Impact of GST on Working Capital for Businesses

The GST, or the Goods and Services Tax, is the most radical and comprehensive tax reform undertaken by the Indian government since independence. The country has already switched to this new, unified, standardized system of indirect taxation, and its effects (both good and bad) have been felt across the industry.

According to the new system, there are four tax slabs – 5%, 12%, 18% and 28%. GST is directly linked to your working capital and can impact the liquidity available for your business. Also known as working capital, this is commonly referred to as the ‘oxygen of a business‘. Here, we will tell you how GST impacts your working capital.

Inventory management

GST has brought about a big change in inventory management. Earlier, companies needed to maintain many warehouses in different states to avoid cross-border taxation costs. It was cumbersome and expensive for businesses to manage so many warehouses while simultaneously complying with the respective tax laws in the state. Furthermore, if these goods had to move to another state, the company would have to pay CST, octroi and other taxes specific to that state.

The upkeep of so many warehouses and compliance with different tax structures put an enormous load on the in-hand working capital of the business. Now, with the introduction of the GST, the company only has to strategically maintain four or five warehouses to fulfil demand in all the states. And when the goods are moved, they do not have to pay taxes every time they cross the border.

This can lead to huge savings on working capital, as businesses need to maintain fewer warehouses. This also allows for the free movement of goods across borders. Another benefit is that transit times are also reduced because there is no tax collection at state borders.

Procurement of raw materials

Before the GST was launched, it was widely believed that it would lead to tax savings for all businesses. Unfortunately, that hasn’t been the case. The business expense differs from industry to industry.

For example, a manufacturer who imports raw material from other countries will now be levied a GST of 18%. Under the old slab, he would only be charged an import duty of 14%. This increase in tax post-GST also results in an increase in a business’s working capital. This is also the case for the service industry, which will be taxed at 18% instead of the earlier 15%.

Due to this change, businesses need to allocate more working capital and set prices taking these factors into account. They also need to find avenues of business finance that will compensate for the higher taxation.

Tax payment timeline

According to experts, this feature of the GST has the biggest effect on the company’s working capital. The GST is levied on goods at the time of transfer. But businesses are allowed to claim tax credit only at the time of sale. The time between the transfer of goods and their sale can be lengthy. Businesses have to wait for the input tax credit when the sale happens. This waiting period causes a sharp drop in working capital, forcing businesses to take a working capital loan.

Additional read: Everything you need to know about the life cycle of working capital

Additional read: Capital budgeting

A final note

GST is a relatively new reform that has been introduced. As with all new reforms, this new tax regime will also take time getting used to. GST has been envisioned by experts and with the fair intention of development of the nation. This is a trying time for businesses, and for them to remain competitive, a proper business plan for utilisation of working capital needs to be put in place.