Working Capital Management Under GST: Strategies for CFOs

Working capital is the lifeline of any business. A working capital crunch is akin to blood ceasing to flow in the body, ultimately causing business operations to halt. For CFOs, working capital management is a daily challenge essential for ensuring smooth business operations. Any changes in law or government policies impacting working capital can be particularly stressful for CFOs. As a result, CFOs must continuously adapt strategies to maintain liquidity and operational efficiency.

The advent of GST and its impact on Working Capital Management

CFOs across industries hold varied perspectives on the impact of GST on working capital.

On the favorable side, CFOs appreciate that GST has unified the taxation system, thereby streamlining compliance and reducing the administrative burden. This has led to improved efficiency and predictability in tax management, which is beneficial for long-term financial planning.

On the other hand, a significant percentage of CFOs also report that GST has negatively affected their working capital. The reasons include delays in claiming Input Tax Credits (ITC) and the requirement to manage more frequent and detailed compliance reports. These issues have led to higher operational costs impacting overall liquidity management.

Looking at the above we can say that the impact of GST on working capital is mixed.

How is GST favourable for Working Capital Management?

1. Unified Indirect Tax System: GST has unified the indirect tax system, allowing for cross setting-off of excise, VAT, and service tax, which was not possible earlier. This mitigates the cascading tax effect and facilitates the seamless flow of input tax credits, resulting in better liquidity management.

2. Streamlined Logistics: The removal of state entry taxes and border check-posts under GST has streamlined logistics, reducing transit times. This enables businesses to operate with lower inventory levels, thereby cutting down inventory holding costs and enhancing working capital efficiency.

3. Online Compliance and Faster Refunds: GST compliance procedures have moved online, resulting in faster processing. This transition ensures timely processing of refunds enhancing overall cash flow management.

4. Broader Input Tax Credit: GST allows for input tax credit on all business inputs, thanks to the “Furtherance of Business” provision. This means businesses can claim ITC irrespective of their direct use in taxable sales, improving liquidity and working capital.

5. Strategic Warehousing: Under the previous tax regime, companies maintained warehouses in each state to avoid CST. GST eliminates this need, allowing businesses to set up fewer, strategically located warehouses, leading to optimal working capital management.

Adverse impact of GST on Working Capital Management

I. Impact of delayed ITC

In GST, effective working capital management hinges on the timely availability of Input Tax Credit (ITC). Moreover, ITC availability depends on the supplier’s compliance, which is hardly in control of the buyer.

Suppliers must file GST returns timely declaring outward supplies and pay the outward tax. If the supplier fails to comply, it affects the buyer’s cash flow. In this case, buyers must reverse the ITC claimed and must pay the tax with interest.

Following are the reasons due to which ITC can be delayed/denied:

(i) When suppliers do not file GSTR-1 timely, ITC does not appear in GSTR-2B.

(ii) If suppliers file GSTR-1 after the due date, ITC only shows up in GSTR-2A.

(iii) Suppliers submitting invoices late can prevent ITC from reflecting in the system.

(iv) Mistakes like incorrect GSTIN, invoice numbers, or tax amounts causing discrepancies.

(v) Improper reconciliation between the books of accounts and GST returns can delay ITC.

(vi) Suppliers reporting transactions as B2C instead of B2B.

(vii) Suppliers incorrectly furnishing inter-state transactions as intra-state, or vice versa.

Denial of ITC due to supplier non-compliance is a significant issue leading to litigation under the GST regime. The GST Department grants ITC to buyers upon producing sufficient evidence of the transaction. However, until the resolution of such disputes, businesses face substantial challenges with blocked working capital. In addition, businesses also need to allocate resources towards litigation, which incurs additional costs and time.

II. Other provisions of GST Affecting Liquidity Management

1. Composition Scheme Restrictions

Composition scheme dealers and their buyers are not eligible for Input Tax Credit (ITC) on tax paid on purchases. This increases the cash outflow and affects working capital for businesses opting for the composition scheme and their customers.

2. Tax on Advances for Services

Under GST, the tax is payable on advances received for services on the date of receipt, but ITC on such tax paid is not allowed until the service is rendered. This results in immediate cash outflow without a corresponding credit, causing a hindrance in effective cash flow management.

3. Delays in GST Refunds

There can be delays in GST refunds, particularly for exporters and businesses dealing with zero-rated supplies. These delays in receiving refunds tie up significant amounts of capital, affecting liquidity and working capital.

4. Extensive Compliance Requirements

GST mandates extensive compliance, requiring businesses to file multiple returns and maintain detailed records. Due to this complexity and frequency of return filings, administrative costs increase for businesses. As a result, the funds that the company could otherwise use for operational needs are diverted into compliance costs, thus affecting working capital.

5. Inverted Duty Structure

In an inverted duty structure, the GST on inputs is higher than on outputs, leading to an accumulation of unutilized ITC. This results in a significant amount of working capital tied up in unutilized credits, as businesses cannot fully offset their input taxes against output taxes.

6. Mandatory Input Service Distributor (ISD) System

The ISD system is mandatory for distributing ITC on common services to various branches or units of a business. Hence, businesses must comply with ISD registration and rules for claiming ITC. Because of these procedural burdens, delays occur in the availability of ITC, which affects overall working capital.

7. Impact of Stock Transfers

According to Schedule I of the CGST Act, stock transfers between states, even within the same company, are considered supplies. Consequently, such supplies are subject to GST. Because of this, there occurs mismanagement in cash flows as output tax is paid on the date of transfer and ITC is claimed only when the branch sells the stock.

Working Capital Management Strategies for CFOs under GST compliances

To effectively manage working capital under the Goods and Services Tax (GST) regime, a Chief Financial Officer (CFO) can employ the following strategies:

1. Supplier Vetting and Collaboration:

Ensure suppliers are compliant and reliable. Furthermore, one can regularly communicate with them to emphasize the importance of timely and accurate GST filings.

2. Regular Reconciliation:

Implement robust reconciliation processes to match purchase records with supplier filings. This includes using automation tools to streamline reconciliation.

3. Documentation and Evidence:

Maintain comprehensive documentation to support ITC claims. Doing this can expedite dispute resolution with tax authorities.

4. Litigation Management:

Set aside a contingency fund to manage potential litigation costs. This strategy will help in preventing diversion of funds which are essential for critical business operations.

5. Cost-Benefit Analysis:

Conduct a thorough analysis before opting for the composition scheme. Consider its long-term impact on cash flows and working capital.

6. Advance Planning:

Forecast cash flows to accommodate the tax on advances. In addition, maintain a buffer to manage these outflows. Furthermore, structure client agreements to minimize advances or adjust payment terms to align with service delivery.

7. Alternative Financing:

Explore financing options like invoice discounting or short-term loans to bridge the gap until refunds are received.

8. Automation and Technology:

Invest in GST compliance software to automate filing and record-keeping thereby reducing manual errors and administrative burden.

9. Managing Stock Transfers:

Plan stock transfers to minimize the tax impact and improve stock turnaround times. Use inventory management systems to track and optimize stock levels across branches.

10. Monitor and Manage GST Compliance:

Regularly monitor GST compliance to ensure timely filing of returns. The result will be reduced penalties, smooth cash flow and optimum availability of input tax credits.

The government is continually striving to improve and streamline GST for businesses. However, CFOs will always face new challenges as amendments to GST regulations occur. Until these changes stabilize, businesses must learn to balance their working capital requirements as per the GST Act’s provisions. Automation and robust GST software can significantly help tackle challenges related to vendor management, tracking non-compliances, monitoring refunds, and ensuring timely return filings. Hence, investing in these technologies shall be beneficial for businesses to adhere to GST compliances and manage their cash flows simultaneously. In addition, leveraging these tools can help businesses achieve better liquidity management, streamline cash flows, and maintain optimal working capital levels.