How Businesses Can Use GST To Manage Working Capital
Every business requires working capital to thrive and flourish. Working capital is calculated as the difference between current assets and current liabilities. It will indicate if the company is equipped to handle short-term costs, such as salaries, inventory, and invoices.
Current assets refer to cash, stock, market securities, mutual funds that can be converted into cash within a reasonable period of time. Current liabilities refer to borrowings, supplier payments, and debts that the company owes during its operating period. While companies will have assets and liabilities, the assets must outweigh their liabilities, so that their working capital is positive. A positive working capital is a sign of a company’s success and will benefit them in several ways.
Goods and Service Tax
Goods and Service Tax (GST) is a tax will be implemented on July 1, 2017 and levied on the manufacturing and service sector. The GST will unify goods and services in a single bill and will do away with the confusing multiple taxation systems, such as VAT, Octroi, Infra Cess and service tax. The GST will be divided into Central Goods and Service Tax (CGST), State Goods and Service Tax (SGST), Integrated Goods and Service Tax (IGST) and Union Territory Goods and Service Tax (UTGST).
Also Read : Is Your Business GST Ready?
Importance of working capital
Working capital is very important for small and large companies and is a crucial factor in their success. It helps companies to stay in operation by allowing them to stock up on inventory and pay suppliers and other debts on time. Paying employees their salaries, logistics and other operational expenses will also come from this account.
At some point in time, companies will require large loans to finance a project. Usually, these loans are required for a short-term basis and have a definitive reason why they are availed. Banks and other financial institutions will determine whether a loan can be sanctioned, based on the working capital of the company to ensure that it can repay the loan. If a company has more liabilities than assets, then it will be burdensome on them to repay the loan. This would make it difficult for them to avail loans as well.
The financial aim of every company is to make profits or to breakeven in the starting years. The working capital of a company is what determines if they are making a profit or a loss. In larger companies, their stock price in the market will be affected if they do not have adequate capital.
Benefits of working capital
The working capital of a company determines how well-managed the company is. A positive working capital can allow companies to expand their business, acquire new customers, buy more inventories and invest in new products or services.
At the same time, if the working capital is very high, then it shows that the company takes very fewer risks and is not utilizing opportunities that allow them to grow. A negative working capital means that the company is struggling to stay afloat.
How will GST affect working capital?
While the GST eliminates multiple taxations such as excise duty, VAT, and service tax, it will increase the current tax rate that is being levied on goods and services. GST will need to be paid monthly as opposed to the quarterly payments that are made in the current system. Due to the increase in taxation rate, the working capital might increase, which will force companies to reconsider their operational costs. They might have to rethink their business models, such as the price of the product or service, their profits, and other financial aspects. It will take companies’ time to adapt to this new model and start functioning efficiently.
Also Read: What is a Working Capital Term Loan?
GST makes tax compliance easier, as goods and services are merged and there will be no distinction between the two. If the cost of manufacturing a good and the cost of providing a service are similar, then it will attract the same taxation rate.
As taxation varies from state to state currently, companies often choose warehouses for their inventory based on tax restrictions. GST will enforce ‘One Nation, One Tax’, hence giving companies the freedom to select their warehouse based on customer location. The transportation and logistics costs will also reduce, as tolls and inter-state taxes will be abolished in this system. This will greatly reduce operational costs and will greatly benefit companies.
GST will affect a company’s working capital in both positive and negative ways. It may take months for a company to adapt to the new rules and to set up a new model that will optimise their business. Vendor procurement rates might change and the taxation rate will increase to 18%, but it is still absolutely possible for companies to make profits by revising their operational expenses and the pricing of the goods and services offered.