What’s been going on at Penguin HQ this week?
Aside from the “fiscal event” aka mini-budget, the big thing we’ve been talking about with clients this week is how the VAT threshold is slowly choking off some small businesses. We’ve also been looking at what your company’s ACTUAL rate of inflation is. Tip: it’s different for everyone 💡
VAT – The Silent Killer for the smaller business
OK so first off, we’re talking about small businesses which haven’t hit the VAT threshold AND sell to consumers rather than other businesses. AKA if they were to charge VAT, their customers wouldn’t be able to claim it back.
If that isn’t you, scroll on by…
Back to basics then: if you’re not VAT reg’d, you can sell something for £120, your customer gives you £120, end of story as far as VAT is concerned.
But if you are VAT reg’d, then of that £120, you have to give £20 to HMRC 😢. So now you’re only getting £100 for the work, but it’s costing your customer the same.
If your customer was another VAT reg’d business, it’s all fine – you’d charge then £120 + 20% VAT, i.e. £144. They claim back the £24 VAT from HMRC and, aside from some extra admin for you both, no changes – they spend £120 and you get £120.
Hence, VAT is a HUGE issue for people selling to the public rather than to other businesses. And as a result, most “B2C” firms will want to avoid VAT registration where possible. Although read this article on when you might choose to register for VAT even before the gov’t force you:
The concept of having a VAT threshold is a reasonable one – if you’re just starting out in business, it means one less piece of admin AND gives you a fighting chance of competing on price against the big boys. Fine.
But the threshold (currently £85,000 per year – and that’s SALES, not profits) actually isn’t that high, and it catches out more and more small firms, perhaps even those with just one member of staff. It’s also perhaps unfair on plumbers (who buy and re-charge lots of materials which don’t generate much profit) and rather more generous for e.g. a self-employed bookkeeper which no real costs to recharge other than their time.
With inflation over the last year or so being sky-high, and companies needing to increase their prices just to stay afloat, we are hearing from lots of people who have inadvertently hit the VAT threshold and all of a sudden find themselves having to hand over nearly 20% of their entire turnover to HMRC.
For some, It’s unsustainable. As a rule of thumb, if you’re turning over between £85K and c. £130K, you’re going to be working a lot harder for not a lot more money (or perhaps even less!), but doing a lot more work. 🤯
It’s different for each client so we will sit down with them, run the numbers and work out how much more turnover they need just to tread water, let alone making additional profits than before. If they have capacity and are planning to be turning over, say, £200K in the new few years anyway, they can just put this down to growing pains, and push through.
But to use the example of an architect I work with, he currently turns over just shy of £85K and reckons the ceiling for his turnover is about £100K. We’ve done the numbers. He’d be WORSE OFF if he worked harder.
Bonkers!
So, counterintuitively, the advice from his accountant 🙋♂️ is to TURN DOWN work which might push him over the threshold. We’re also looking at ways to increase profitability on existing work such that from his £85K turnover he can generate more profit.
Why are so many people being caught out?
Here’s the thing. Income Tax and National Insurance thresholds broadly keep pace with inflation – today’s personal allowance of £12.5K compares with just £4.6K twenty years ago. Over that time, it’s increased by about 8% per year, which (until last year at least!) was well above inflation, which is a GOOD THING for taxpayers.
Compare that with VAT. Twenty years ago, the VAT threshold was £56,000 – hence we have seen an increase of just 2.5% per year equivalent. This is well below inflation, and you can see how small businesses, even if they aren’t “growing” in the conventional sense but just nudging up their prices to keep up, end up in the jaws of VAT.
Accountants love numbers, so I thought it would be “fun” to look at the movements in Income Tax vs VAT over the last twenty years. You can see from the graph there is a clear disparity between the two. The gov’t tells us the increase in Personal Allowance is “taking people out of income tax” but is remarkably silent about the VAT…
A picture paints a thousand words and all that, so I’ll just leave you with this thought:
Registering for VAT could be the worst thing your business ever does. Or it might not. Speak to an accountant before you make the leap.
Your Business rate of inflation
5%… 10.7%… 15%…
Different days, different newspapers, different “official” inflation figures etc.
However you slice it, it’s the word on everyone’s lips at the moment and let’s make no bones about it – this WILL affect you and your customers. Stuff is costing more. You only have limited capacity to absorb the cost (aka making less profit without going bust). Some of this NEEDS to be passed on to your customers.
“How much to charge” is the subject of a much bigger discussion (search the blog for more details on this), but at the very least you should ensure you aren’t making LESS than you were last year. And that’s bearing in mind that even earning the same in ££ terms means less ‘stuff’ you can actually buy with the cash.
Every business has a different make-up of costs, and will be affected by inflation in a different way.
Take Blue Penguin for example. You won’t be surprised to know that about 80% of our costs are wages. So for us, energy costs – whilst only going up – form a relatively small part of our overheads. But inreases in wages costs make a huge difference.
This year we’ve agreed a c. 5% increase in wages costs, and next year I’m expecting it to be a little higher again. So, when working out what we’re going to be charging our clients to do what we do, that’s the sort of figures I need to take into account, just to stay still.
Of course, I also need to make sure that it still represents good value for our clients else they will not be happy.
But compare us to a client selling metal widgets. They have staff, sure, but they mainly have lots and lots of widgets, which they purchase, store and then sell. The increase in wages costs isn’t so much a factor for them as the increase in the cost of their widgets. Making metal is energy intensive. The costs to purchase the widgets are going to go up. They need to make sure their customers can absorb the increase.
And let’s say this business also has a mortgage on the warehouse – interest rates are shooting up at the moment, so their interest repayments are going to DOUBLE. All of this needs to be paid for somehow. And if your customers genuinely cannot pay a penny more for your products, you need to ask some tough questions about whether you can afford to absorb the extra costs just to keep the staff paid and the lights on. Or whether you need to start looking at new markets – or different suppliers? – for your products, to keep the wheels turning.
Do one thing for me today:
Ask your suppliers (if you haven’t already) what sort of increases are around the corner for 2023. Then take your 2021 or 2022 figures from Xero/Quickbooks, bung them into Excel and update all the costs to what you think they will be next year. This will hammer your profits (quite likely it will show a loss!). This tells you the sort of gap you need to fill, either by trimming costs, selling more stuff, or selling the same amount of stuff for a higher price.
Each market is different and so your solution will be unique to you.
Of course if the thought of getting fancy with Excel brings you out in hives, speak to your accountant, they can do all of this for you and tell you how bad it’s gonna be… 😬
But we know there are tough times ahead. And, as they say, forewarned is forearmed. 💪
Right then, I’m off now to take the dogs to the groomers… 🐶
