A new year is a time to sit back and reflect, plan and resume our ambitions. Businesses have never felt a greater need for some clarity and direction in their growth than now. With the hair and beauty sector either in lockdown or working at half capacity for three quarters of 2020, this has had a devastating impact on cash flow and perhaps confidence and morale.
With rule changes and uncertainty set to continue for at least the next six months, what should we do?
Understanding the VAT system
I believe you should try to understand the UK’s VAT system, how it affects your profitability and how it could ruin your business.
You should be aware that increasing revenue does not always equate to bigger profit and the impact it has at the VAT threshold (£85,000) can be equally damaging significantly beyond that figure if you don’t know your numbers. Your profit margin (sales less fixed costs) has to be your driving force and not your turnover.
Understanding VAT will help you make better informed decisions about your business, make a healthier profit and give you a calmer mind because you know where your money is going.
Financial advisors may tell you to get an app to help set money aside for VAT. Although this is sensible advice, it’s not as simple as that. I will therefore try and summarise the two biggest issues that I feel are particularly relevant to the hair and beauty sector.
My frustration is the current VAT system does not take into account two major points:
1) VAT becomes payable on 100% of annual turnover at the point of registration, rather than just the sales over the current £85,000 threshold.
At this point, extra turnover doesn’t equal extra profit. In fact, unless you increase turnover significantly, you will end up making less. I would liken it to a huge financial ditch appearing when businesses hit the VAT threshold. Unless the salon owner has the resources to get to the other side of the ditch their business could get stuck. If the water level is low enough, they could wade through, and if they are a strong swimmer (that is, they have the savings or financial resources), the salon may be able to sustain itself to meet its tax obligations.
2) For hair and beauty businesses, the major cost is staff.
This is a fixed cost where you can’t claim back the VAT (as you can with purchases of goods). When staff are away due to holidays, illness or maternity/paternity, this impacts the business financially.
If your business has grown comfortably to the extent that you are now employing a number of stylists, you are legally obliged to give 5.6 weeks holiday to each team member. In practical terms, this means that for 5.6 weeks of the year per stylist, you will be operating with reduced revenue but with the same fixed costs. This is before the salon owner has taken a single day’s holiday or accounted for any sickness or maternity/paternity absences. The nature of the hair and beauty business means your gross profit is likely to fall significantly and your ability to meet your VAT bill is reduced.
The hair versus retail business
A department store can still sell jumpers if an employee is on holiday. In a hair salon however, a client can only see a different stylist if that stylist has capacity to take on the extra work so fewer ‘sales’ are made when a stylist is on holiday. This imbalance can trip up the strongest of businesses, so take this into consideration.
VAT is complicated and affects self-employed freelancers and big salon groups in equal measure but at different points. It is a tax that is meant to be passed on to the consumer but in reality it frequently gets absorbed by the business. The challenge for a VAT-registered business is that it will need to raise prices overnight by 20% to compete on the same level as a rival business that is not VAT-registered because its sales are below the £85,000 threshold.
The bigger VAT argument
We must understand the numbers that are relevant to our business so we can make informed decisions. We should also work as a collective to raise awareness and call on the UK Government to address the system and create a level playing field for growth that is sustainable for everyone.
Maria’s key questions to consider in 2021
Ask yourself these three key questions if you want to avoid VAT ruining your business this year
1 What gross profi t margin did you make in your last Profi t & Loss account? Use this information to help you identify if the pandemic of last year exposed a weakness that could be addressed.
2 What revenue stream makes you the most profi t such as cut and blow-dry, balayage, roots or a gloss? Identify which services eat up your time and profi t and which services make you fi nancially viable?
What profi t would you realistically like to make? Ask your accountant what turnover you will need to make times amount of profi t.