It's not too often that you hear business experts recommending VAT loans to pay off existing tax bills. But the reality is that sometimes these loans make a lot of sense. If a business owner is having to make the choice between getting in trouble with the taxman and not being able to pay other bills, neither choice is really optimal. A short-term loan could be a good stopgap measure to get that business owner through a cash crunch.
VAT, also known more formally as value-added tax, must be collected and paid by most businesses that sell goods and services. Business owners must file VAT returns each quarter regardless of how often they make payments. The problem is, VAT payments do not necessarily coincide with periods of high cash flow. Sometimes a business owner will find him/herself in a cash crunch at the very same time the tax bill comes due.
Cash Flow Is Critical to Business
Given that VAT is collected on goods and services, it most often applies to businesses operating on a business-to-consumer (B2C) model. These kinds of businesses have an intense need for cash flow. Take a retail store, for example. That store needs access to cash to cover things like payroll, inventory, and daily business expenses. It cannot have more cash going out than coming in if it is to remain viable.
When having to make a choice between financing VAT payments and running out of cash, the former tends to be more appealing to business owners. Sometimes it is better to preserve a company's cash assets by taking out a loan to pay taxes. The loan can be paid off over several monthly instalments, thereby making the tax burden a bit easier to bear.
Avoiding Action by HMRC
UK business owners are fully aware that HMRC has been aggressively cracking down on tax cheats in recent years. Tax collectors are not afraid to go after small businesses that aren't paying their VAT bills on time. This is the kind of trouble business owners just do not need.
HMRC typically sends out warning letters when they discover a business hasn't paid its bill. They are also known to be somewhat lenient about extending the time to pay bills, but only up to a point. Businesses that find themselves consistently behind in VAT payments could wind up in court. If you have to make the choice between taking out a loan and doing battle with the taxman in court, which option sounds more appealing?
Overwhelming January Bills
The third scenario in which VAT loans make sense occurs just after the first of the year. January is when a whole host of bills typically come due. Businesses are faced with quarterly VAT payments, rental payments, and even issues with their own receivables. Things are not made any easier by the knowledge that a second cash crunch is coming in April.
January is one of the most stressful times on business finances. Business owners have to look at their total cash positions as they simultaneously embark on the new year and attempt to close out the previous year. It is not hard for the tax bill to fall down the list of the business owner's priorities.
In a perfect world, business owners would collect VAT and immediately set it aside so that there is money in the bank to pay the bill when due. But this isn't a perfect world. VAT collections tend to go into the general fund and used to support cash flow. For this fact alone, VAT loans sometimes make good sense. They should not be the sole means of paying tax bills, but they can be a big help under certain circumstances.