Should You (Really) Model VAT / Sales Tax? [Free Template]

We often get the question from entrepreneurs and founders: should I model VAT (or “sales tax” in the US) for my budget?

Because it doesn’t affect profitability, VAT is almost always excluded from your profit-and-loss (or “income statement”). Yet, VAT does impact cash flow. So should you model VAT? And how?

In this article we’ll explain you everything you should know about whether you should model VAT and sales tax for your budget and financial forecasts.

Note: for simplicity and the sole purpose of this article we’ll use VAT as a term both for VAT (Europe, UK, etc.) and sales tax, which essentially is the same as VAT for the United States.

You Shouldn’t Model VAT When

As explained above, VAT and sales tax are excluded from businesses’ income statements (at least for registered VAT businesses).

The reason simply is that VAT has no effect whatsoever on your business’ profitability. Indeed VAT is both recorded as a revenue and an expense at the same time, so effect on your bottom line is zero.

That’s why we almost never model VAT when we prepare financial forecasts for fundraising purposes.

Unlike budgeting which is typically over a 12 months period, financial forecasting is over 3 to 5 years, and the most common type of financial projections. So why do we say fundraising purposes here? Financial forecasts are used for fundraising (the financial projections you would include in your business plan or pitch deck for example).

If you want to know more about the difference between financial forecasting vs. budgeting, read our article here.

You Should Model VAT When

VAT doesn’t affect profitability, yet it does impact cash flow. So when should you model VAT for your business?

If you’re preparing a budget for your business, you might want to accurately forecast your cash flow movements. Indeed, budgets typically are shorter projections (12 months). Also, they’re mostly used for monitoring cash flow.

That’s why you may want to model VAT for your 12 months budget.

Indeed, if you’re preparing a budget for the next 12 months, there’s a high likelihood your projections will be somehow accurate (more so than 3-year financial forecasts). Therefore, you can go more granular and include the impact of VAT on your cash flow.

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How Does VAT Impact Cash Flow?

As we’ve explained already, VAT doesn’t have any impact on your business’ profitability. That’s the reason why it’s excluded from your P&L.

Yet, VAT does impact cash flow. The impact depends on:

  • The VAT percentage you receive from your sales, and the one you pay your suppliers
  • The proportion of your revenues and expenses that are VAT exempt (if you’re dealing with overseas customers only, you might not have any VAT at all)
  • The periodicity of your VAT payment and returns (for example, UK businesses need to file a VAT return on a quarterly basis to HMRC ; the US is more complicated as it depends in which state your business is dealing)

Aside from the jurisdiction you are in, and the type of business you have, VAT impact on cash flow the same way for all businesses. The impact can be summed up as follows:

For customers (revenues)

  1. VAT is an inflow in your cash flow statement. It adds up in a VAT payables account in your balance sheet: it’s owed to authorities but not paid yet
  2. Once you file your tax return, you will pay to the tax authorities the VAT you owe them. This will reduce your VAT payables account by the same amount

For suppliers (expenses)

  1. VAT is an outflow in your cash flow statement. It adds up in a VAT receivables account in your balance sheet: you paid it, yet it will be refunded to you by the tax authorities
  2. Once you’ve filed your tax return, the tax authorities will refund you the VAT you paid your suppliers over the period (a quarter for example). This payment to you will reduce the VAT receivables account by the same account

How To Model VAT For Your Budget? [+ Free Template]

If you decide to model VAT for your business, you should model VAT as you would do for working capital:

Download our free template below to get a clear idea of how VAT should be modelled. Feel free to reproduce and/or adapt to your own budget template.

Fundraising?

Download a financial model template, fill it out in minutes and get funded

  • 20+ charts & metrics
  • Video tutorial
  • Free expert review