- The financial aspect of vat and how it will affect the business’s cash flow
The financial aspect of vat and how it will affect the business’s cash flow
- As clarified in the Elasticity Section, elasticity serves as a vital tool for businesses and their decision-making process. Over time, producers and corporations will be able to explore the type of elasticity their goods and services fall under and thus make more accurate decisions on recruitment, level of output (units produced) and other marketing decisions such as advertising. Elasticity on its own is a major indicator of the effect on demand of a certain good or service upon a 5% VAT increase. In the working example above, a limited number of goods and services have been mentioned.
- However, since the ‘spectrum’ of goods and services include a large number of types of products, corporates and producers may want to examine the impact of 5% VAT increase over and above their selling price on the demand of consumers.
- Nevertheless, elasticity on its own plays a role in observing sales and on the impact of higher price upon adding VAT. The other main source that decision making will be based upon is the impact of VAT on the production process and costs. Thus, assuming VAT at 5%, the production process will inevitable and generally increase. As a result, the increase in the cost of production will eventually deplete resources available to the producer and in turn, reduce the capability to produce a big output of finished goods.
- Those financial consequences lead to a shuffle in the producer’s’ cash flow. The lower sales as a result of lower demand and higher costs in terms of VAT on stages of products may lead the producer to make fresh decisions in the medium and long term. Such decisions may include introducing new marketing budgets to boost demand through advertising and, from cutting production costs point view, reduce manpower and other unnecessary costs. In the long term, however, when cash-flows shuffle returns to a steady state and demand recoups it losses by means of advertising, companies will be in line with adaptation to the impact of VAT and seek to return to their original size.
- The impact on VAT on costs of production will lead many producers to seek lower costs of raw material to compensate for the value added percentage. This move primarily aims at reducing the outflows vis-à-vis raw material costs. Reduction of outflow (costs and expenditure) can be also tackled by seeking inexpensive resources to complete the production process.
- As for financial decisions made by importers, the marginal cost of VAT can be compensated by seeking new exports markets where the crude cost of goods and services are lower. By doing so, sellers of imported output may be able to absorb the VAT on the overall selling price and, in turn, limit the negative impact on demand.
- Generally, the key principles in making investment decisions are that the economic calculations used to justify any business investment must be based on projections and forecasts of future revenues and costs. The introduction of VAT leads to a new picture through which the entire investment framework is manipulated in terms of inflows and outflows. Once the VAT is introduced, it’s no longer enough to assume that the past conditions and experience, such as operating costs or original product prices, will continue unchanged as VAT will manipulate such prices leading to a new revenue state. Hence, while financial positions and cash flow forecasts rely primarily on the gap between inflows (revenue) and outflows (costs and expenditure), this very net cash flow (profit or net earnings) shall inevitably change upon the implementation of VAT in the economy. It is thus the responsibility of those financial analysts and economic planners within the business organization to analyze the impact of VAT on their production process, selling process, marketing and financial operations at the earliest possible; preferably even before the commencement of implementation of VAT in the economy. This can be done by examining factors that may reduce the impact on demand along with seeking less expensive resources to make up for the marginal increase in selling price caused by the value added tax. All business organizations are aware of the fact that any additional sum on a selling price leads to an adverse effect on quantity sold which in turn shrinks total revenue. To confront such adverse conditions and to keep sound cash flows, enterprises shall engage in arithmetic analysis on their past and existing cash flow statements/forecasts. In other words, prior to the introduction of VAT, corporates may have to engage in making assumptions on the impact of higher prices on their goods and services. This may include paradigms of simple demand tables where permutations of prices can be used to calculate the percentage fall in demand versus the percentage increase in price. If VAT is assumed at a certain percentage, say 5% sellers will resort to past experience when the price was increased at the latter percentage. Thus, the corporate will position itself in such a defensive position prior to VAT announcement and rectify their cash flow expectations accordingly. Finally, once such positioning is established, remedies to the adverse financial impacts of VAT will be adequately tackled even before VAT is in action.