VAT's impact on a construction business's cash flow

8 June 2022

“Surely VAT has no impact on business cash flow for a VAT registered construction business that can recover all of the VAT pays incurs on its costs?”

The answer may surprise you.

In many construction businesses, VAT is between 30 – 40% of all cash flowing through the business. However, the majority of those businesses don’t spend any of of their resources managing this important cash flow. Simply filing VAT returns and paying any VAT due on time is as far as most businesses ever get in thinking about VAT cash flows.

VAT may very well be the cash flow/working capital iceberg that's lurking below the financial surface of your construction business.


so… Where’S the VAT in your business?

If you try to find VAT in your financial statements or management accounts, all you’ll see is a single figure in the balance sheet that simply summarises the amount you’re due from, or due to, HMRC at that point in time.

So what’s happening here?

VAT’s not typically found anywhere in the profit and loss account of the typical construction business. To find it, you’d need to look at your creditors in the liability section and the debtors in your asset section of your balance sheet.

If you pay VAT on the goods and services you buy, VAT’s embedded in the creditors balance.

If you charge VAT on the goods and services you sell, VAT’s embedded in the debtors balance

HMRC are either owed VAT, or owe you VAT overall, and that net figure’s the VAT balance in the balance sheet.

So, the true picture’s that trade creditors are financing your business in terms of VAT – you’ll still need to pay them as part of their creditors balance. You’re financing your customers’ VAT in terms of the VAT they’re due to pay you as part of your debtors balance.

HMRC’s either a debtor/creditor in terms of VAT you need to pay or recover from them when you file your VAT return.

“So what?”  

If you’re with me so far, you’ll start to see that in a business that pays VAT at 20% on purchases and charges VAT at 20% on sales, knowing what your VAT return periods are, and when they must be filed and VAT paid or recovered, is crucial.

For example, let’s say you invoice a customer VAT on the final day of your quarterly VAT return period. That VAT must be paid over to HMRC whether the customer pays or not – normally in 37 days’ time. However, if you invoiced them one day later, you’d have 127 days normally before you had to pay HMRC. That’s a big cash flow difference.

There’s a special VAT scheme known as ‘cash accounting’. This helps businesses that must wait for customers to settle their invoices and have few variable costs. This allows VAT to be paid to HMRC once payment has been received from the customer.

For some construction businesses, this may not be helpful when they’re paid immediately on application/certification.

There’s simply not enough space in this article to go through all of the steps you could take to improve your VAT cash flow and working capital, but being aware of the impact on VAT on your construction business is an important first step.


Domestic reverse charge on construction services

A quick note for construction businesses that have to use these VAT rules.

These changes to the VAT accounting rules were introduced on 1st April 2021 and resulted in a big change in the VAT cash flow profile of many construction businesses affected.

Some subcontractors found they were left in an overall worse cash flow position. While they still recovered VAT from HMRC on materials purchases, they no longer received the VAT cash inflow on their sales. This is because they were no longer charging VAT on sales to their main contractor and enjoying the use of that cash until the VAT return was filed and paid. Essentially, they found they were paying out VAT to suppliers and no longer collecting any VAT receipts from customers. For such businesses, filing monthly VAT returns could be the quick fix, but it illustrates the strain that the changes put on some construction businesses.

There’s an added complexity from the VAT rules that apply to the liability of residential construction work vs commercial projects and whether your business is providing construction services to an end user.

All of these factors will impact the VAT liability of sales and require some extra thought to understand the VAT cash flow position.

QUICK WINS

Here are five simple questions I recommend you look at in the first instance…
  1. Should you be filing monthly or quarterly VAT returns? If you’re in a VAT repayment position, perhaps filing monthly would improve your cash flow.
  2. If you’re invoicing customers at a VAT period end, would a day delay help your VAT cash flow without damaging your billing/cash collection position?
  3. Are your finance team booking purchase invoices into your accounting system quickly enough so that any VAT you’re invoiced is being recovered in the correct VAT period? Remember, if you receive a valid purchase invoice with VAT on it, you have the document that supports VAT recovery before you even think about when you’re going to pay it.
  4. Are there large purchase invoices on your senior team’s desks for approval that your finance team are unaware of? Again, if you have a valid VAT invoice, you may be delaying VAT recovery by not getting it logged on your accounting systems.
  5. If customers are long overdue payment (e.g. six months overdue) have you claimed the VAT bad debt relief you may be entitled to? Even if the customer subsequently pays, the VAT cash flow boost might be very welcome.
If you’d like to explore the topic in more detail, please do drop me an email

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