Understanding VAT in your Fashion Business
Tax and accounting can be one of the most confusing areas of business and often seems very far removed from the set of skills and interests that led to you starting up in the first place. VAT can seem more confusing still. Do you need to register for it at all? How does it work? What are the advantages and disadvantages? Fortunately, though the rate goes up and down, the basic rules of VAT rarely change, so once you understand them you'll find it easier than it looks.
How VAT WorksNot every company has to register for VAT. You will not normally be required to register until your business has an annual turnover of over £70,000. This gives you a bit of time to find your feet and get used to managing your other finances before you have to deal with it. For some businesses, however, it can be advantageous to register early.
VAT is a tax on goods and services at the point of consumption. It applies every time a product or service changes hands, but you can gain from VAT as well as having to pay it. This is because there are two types of VAT:-
- Input Tax - VAT charged to you by your suppliers (often included in the price just as it is when you buy things as a private individual).
- Output Tax - VAT you charge on the products or services you sell. You will usually include this in the price of the clothes you make, but as you will be saving money when you buy stock, this doesn't mean you will necessarily need to charge more.
Every business registered for VAT has to fill out a VAT form and submit it at the end of the financial year. It's important to keep track of all your incoming and outgoing VAT by attending to your accounts at least weekly. The form itself is relatively simple and can now be submitted online.
Why Register for VAT?Although it might seem like a lot of extra hassle to register for VAT before you're obliged to, there can be several advantages for small businesses. Firstly, you may be eligible for special rates that can generate extra income. Secondly, you may be able to pay reduced rates of VAT on special purchases aimed at making your business more environmentally friendly. Thirdly, VAT can help with your cashflow.
How does this work? When you pay VAT on goods you buy for your business you can claim it back from HM Revenue and Customs each quarter, even if your bank account has not yet been charged for your purchases. This can give you extra cash in the short term to make your finances more flexible. The down side is that you will have to pay VAT on items you've sold even if you have yet to receive payment.
What this means is that registering for VAT is good for businesses whose suppliers are slow to take payment (for instance, suppliers who let you keep a tab which overlaps the quarterly VAT period) if they are also good at chasing up their customers for payment. If, for instance, you run a market stall and sell all the clothes you make for cash, VAT could be a great choice for you.
Alternative VAT SchemesSpecial VAT schemes also make registering a good choice for many small businesses. If, as a clothing business, you register for the Flat Rate VAT scheme, you can charge VAT at the standard rate but you only have to pay it back at around half that rate (the actual numbers change slightly from year to year). The process is simplified and you will also receive a 1% first year discount, but it's inappropriate if you sell children's clothing, on which you can't charge VAT.
The Cash Accounting Scheme reverses the usual VAT arrangement in meaning that you only have to pay VAT after you've received money for your sales but you can't claim VAT when you have bought goods and not yet paid for them. This is good for businesses whose suppliers demand instant payment and whose customers are slow to pay.