Category Archives: Budgeting

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The Symmetry of VAT

I’ve blogged before about how VAT works, so here, I’m just going to highlight the symmetry of the VAT chain in the UK by considering a hypothetical supply chain of VAT-registered businesses, Company, A, B, C.

Company A makes a widget and sells it to Company B for £100+VAT = £117.50
Company A’s output VAT (the VAT on it’s sale) is £17.50 which it pays to HMRC
Company B’s input VAT (the VAT on it’s purchase) is also £17.50 and can be reclaimed, giving a cost of only £100
Company B does a bit of additional work and sells the super widget to Company C for £150+VAT = £176.25
Company B’s output VAT (the VAT on it’s sale) is £26.25 which it pays to HMRC
Company C’s input VAT (the VAT on it’s purchase is also £26.25   and can be reclaimed, giving a cost of only £150
Company C does a bit more work and sells the resulting super-duper widget to D for ££200+VAT = £235
Company C’s output VAT (the VAT on it’s sale) is £35 which it pays to HMRC.

Let’s suppose that D, is a private individual, who is therefore not registered for VAT.
D therefore cannot reclaim the £35 of VAT that it’s paid.
So the total cost to D is £235.

D bears the entire cost of the eventual VAT charge.

If a business is making zero-rated supplies, (ie, the products or services it sells), it charges VAT at zero percent, as opposed to charging no VAT.  The distinction, although pedantic, is important: These businesses can reclaim all the VAT on the purchases.
(Some examples of zero-rated goods are given here)

If a business is making exempt supplies, it cannot charge VAT on it’s sales and it cannot reclaim the input VAT on it’s purchases.
If a business makes only some exempt supplies, it would only be able to claim the VAT on purchases related to it’s VATable supplies.  (The Partial Exemption area of VAT is a whole huge area of VAT rules, in itself, which I will address in a later post)

A business that is unregistered for VAT or a private individual, is completely outside the VAT system.  Obviously, they cannot charge or reclaim any VAT at all.
HMRC deems these businesses and individuals to be “out of scope“.

Production

If you are a manufacturer, you need to detail how you are going to produce the goods, literally.  For example: what sort of equipment is required?  Where will manufacturing take place?  What are the costs involved?  What are your timescales? Where will your materials come from? Who are your suppliers?

This section also encompasses things like quality control and how production will be organised and managed.

Distribution and Administrative Expenses

Distribution Costs
As the name suggest, this is the cost of transporting your product to your customers

Administrative Expenses
This includes expenditure on head office premises, administrative staff and overheads.

Apportionments
It is frequently impossible to categorise an item of expenditure as purely distribution or purely administrative.  When this is the case (for any item, not just distribution or admin expenditure), an apportionment of the expense across headings is allowed.  This is a very common occurence.  The basis for the apportionment calculation will vary depending on what the expenditure is and can be very straight forward or incredibly long-winded.  Indeed, for some accountants, in bigger companies, deciding on and making these apportionments can be the bulk of their full time job.

Gross Profit or Loss

Turnover
In the Profit and Loss Account, turnover is the income you generate through your sales.  (Investment income, which will be the subject of a future blog, is dealt with elsewhere)

Cost of Sales
This is basically all the direct expenditure incurred in generating your sales.  Therefore, the cost of stock and raw materials will be included here.

Gross Profit or Loss
Turnover less Cost of Sales gives the Gross Profit or Loss

Other Employee-Related Costs

Here are some other employee-related costs: 

  1. “Overhead” costs of office accommodation.  You will still have a certain amount of costs even if they work from home, such as phone call costs, an internet connection, travel and possible contributions to heating and lighting.
  2. Depending on your business, cover for holiday, sickness and absence.
  3. Initial training.
  4. Ongoing training and development opportunities.
  5. Insurance.
  6. Payroll costs

Yet, after doing all of these things, you need to be prepared for the fact that one day, your new employee will probably leave you.  A job is rarely for life.

HR Cost of Employees

Once you employ someone, you need to consider a whole range of Human Resource issues.  Most of these will also have financial implications, whether that be the cost of your time or someone else’s in terms of becoming aware of everything you need to, to the explicit cost of running or oursourcing an HR function.

The most obvious HR cost is the cost of recruiting someone.  There will be the obvious costs of advertising in newspapers or on the internet.  Maybe you will need to hire a recruitment consultant; agencies normally charge a percentage of the new employee’s gross salary.  (These may be scaled down or refunded if the employee leaves  within a short timeframe).

However, there are also ongoing costs arising from the need to be aware of employment law and other employment issues, such as grievances and disciplinaries, maternity rights, sickness and absence management and equal opportunities, to name a few.