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Inflation, VAT and NI – The story of rising business costs

It feels at the moment as though business owners are being attacked on all fronts in terms of cost hikes and no industries have been hit harder over the last 2 years than the hospitality, events and cultural sectors.

We’re used to prices going up every year, whether that be energy, supplier costs or wages. But this year is a particular cause for concern for business owners as the current cost increases coming into force (some already have) could quite literally mean the difference between breaking even and closing their doors for good.

 

What costs are on the up?

If you’ve got a T.V (and the time to watch it) you’ll have seen that inflation is on the rise. The rate of inflation is the speed at which prices increase. The Consumer Prices Index (CPI) rose by 5.5% in the 12 months to January 2022. This is the highest 12-month CPI inflation rate since the ONS started keeping track in 1997.

Inflation is linked to the rise in supplier prices- the higher the demand for a product, the harder it is to source and the more prices start to creep up. Covid (I’m sure we’re all sick of hearing about it) hasn’t helped- demand for non-essential items slumped whereas the demand for perishable items rose significantly.

Employer’s NI is set to rise by 9.06%- the first rise since the 2010- 2011 tax year. The rise comes in the guise of a Health & Social Care levy which aims to recoup some of the cost of Covid over the coming years. Combine this with the increase in NMW and NLW and Employers’ wage costs will see an average rise of between 5.23% and 13.06% in the “true cost” of wages (the hourly rate/ salary of staff plus ER’s NI plus ER’s Pension).

And lastly (as if the first 3 weren’t enough) we’ve got the reversal of the reduced VAT rate for Hospitality. Hospitality and Events business owners will see the reduced rate of VAT @ 12.5% revert to pre-Covid levels of 20%

 

External Factors influencing inflation

Inflation- that horrible thing we hear about each year but don’t really understand anything about. What we do know though is that it means prices are going to go up! The Bank of England (BoE) expects the inflation rate to rise to over 7% in Spring 2022 but to take a downward turn during Autumn. The BoE expect the rate of inflation to level out to a much easier-to-swallow level of 2% over the next 2 years. In the meantime, however, this means a bit of a hike in prices across the board as suppliers of all kinds attempt to recoup some of their own ever spiralling costs.

Energy prices are also on the rise. Again, this has a fair bit to do with inflation as well as being dependent on the weather. A colder-than-usual winter across Europe combined with a lot of people working from home has severely squeezed the amount of gas stored. A relatively windless summer in 2021 made it much harder to generate electricity through wind. These factors (along with others) have inevitably led to a rise in energy prices and some suppliers being unable to cope with the increase. As a direct result of these suppliers having to fold, Ofgem have had to raise the energy price cap by a staggering 54%.

 

 Internal Factors tied to inflation

Hospitality businesses have always tried to keep costs down for the end consumer mainly because if you’ve got a similar offering to another pub/ restaurant or hotel down the road, then how do you keep customers without keeping your pricing competitive? You almost end up in a bit of a stalemate- you don’t want to increase your prices as you may lose out to your competitors, and they won’t increase theirs for the same reason.

The only way around inflation is to bring up your own prices. We took a look through our own clients’ menus over the past few years and discovered that the only real increases were on booze and those increases largely fell in line with announcements of tax hikes on booze prices. Food prices have almost never been amended with the exception of adding new items to the menu.

But how do you increase your revenue without losing out to your competition? There are dozens of different ways to effect your revenue, but we’ll focus on three key points that are going to be much easier to follow than changing your whole business dynamic:

  1. Increase average Spend Per Head (SPH). If my days sweating away in McDonalds as a youth taught me anything it’s that there is no limit to the amount of fast food you can scoff down in a day whilst your manager isn’t looking and increasing your SPH is the quickest way of generating revenue next to putting your prices up massively. E.g. if you’re turning over £5,000 per week on food and your current SPH is £10 then increasing this by an average of £1 per head leads to an extra £26,000 in revenue per year. SPH can be increased primarily via upselling (exactly like in Maccy Ds when the ask if you want to go large).
  2. Not a thing we often do in our industry but more often than not if you’re going through something, then your competitors are too. If you’re worried about raising prices, then have a chat with them- see what they’re doing and potentially agree to raise prices at the same time. I can guarantee that this won’t have a negative effect or even push you out of business, you know why? Revenue is only generated where competition is involved- McDonalds won’t open a new location unless there’s already competition in the area. The more competition available the better as more business is attracted. Speak to other local owners and ensure that whatever offers you both have on are taking place on different nights (if possible) so that you’re not creating an “us or them” scenario for your patrons.
  3. Increase your prices. Quite simple really. Every business across every other industry or profession is given the advice “know your worth”. If you’re providing an exception service with great food and drink then charge for it! People often shirk at menu prices in restaurants but that’s usually because they don’t understand all of the work that goes on behind the scenes. An easy way around this is to educate your customers- a couple of short videos here and there on social media showing the processes involved In bringing a dish to life will definitely give your customers more faith in your pricing and in the business itself!

 

The rising cost of employment

It’s hard as a business owner trying to find the balance between retaining good staff and paying yourself a living wage through the business that you’ve spent a great deal of time getting set up.

Increases in the National Minimum (NMW) and National Living Wage (NLW) are no bad thing, and a small increase can mean the difference between living and going without for those on a lower income.

The problem arises when an already struggling industry must fork out an extra 9.06% on National Insurance costs. Add this to the fact that hourly rates are increasing by an average of 7.30% with those in the 21–22-year-old bracket getting the largest increase of 9.81% and you end up with an overall increase per hour of between 5.26% for 16-20-year-olds and 13.09% for 1st year apprentices.

The question then arises of what happens with management or salaried staff? A head chef or bar manager on £26,000 per annum has an equivalent hourly rate of £10.42- it may hardly seem fair to them that they’re only being paid £0.92 more per hour for all the extra responsibilities and tasks that come with the job, so a comparative rise may also be required here to keep their salaries attractive and to retain your management team.

 

With the cost of employment increasing, how do you maintain a strong team whilst recruiting others to build your business? One previously not-so-popular method is now gaining traction and it revolves around service charges.

Service charges are a decent way of ensuring that your staff are paid for the great service they give and amazing food that they cook and the only cost to you is your Merchant Service fee for collecting the payment. For both staff and employers to benefit from this, the service charge must be optional and split out by a troncmaster. It is the tronmaster’s job to run payroll and report information on tips, gratuities, and service charges to HMRC.

If tips, gratuities, and service charges are run by a troncmaster as opposed to the employer, then only PAYE tax is due. If the employer intends to run a tronc, then PAYE, Employee’s and Employer’s NI and pension contributions all apply. Employers should not retain any form of gratuity for themselves as this wi

ll count as earnings and subject to Corporation Tax although new legislation is coming into effect this year to stop the practice of employers withholding staff tips, gratuities, and service charges.

If you run the tronc system yourself, each £100 that is received will cost you 13.8% in NICs (15.05% come April 2022) plus 3% pension contributions. Staff will al

so have to pay 12% NICs (13.25% come April 2022), 5% pension contributions and 20% income tax.

Here’s a little example of the cost to the employer per hour per 2 staff members:

 

VAT on the way up

Back in July 2020 the Government announced a temporary 5% reduced VAT rate for hospitality, accommodation, and leisure. The reduction applied to a wide range of things, and it’s been a somewhat of a lifeline for a fair proportion of the industry. The 5% reduced rate continued up until 30th September 2021 at which point a new reduced rate of 12.5% was introduced. The 12.5% reduced rate is due to end this month and VAT rates will revert to the pre-Covid levels of 20% across the board for standard rated products and services.

The increase won’t have any real effect on B2B services or businesses that provide products and services ex. VAT. Near enough all-hospitality businesses provide their services and products at VAT inclusive pricing as they are mainly catering to the general public, and you’d have a hard time explaining to Dave at the pub why his pint is actually costing 20% more than it says on the menu!

 

This increase will have a devastating effect on those businesses that haven’t managed to maintain a decent enough EBITDA as the increase in VAT will mean a direct reduction in their products’ NET price and therefore result in a drop in profit (for those not in the know, EBITDA stands for Earnings before Tax, Depreciation and Amortisation. Basically, a fancy way of saying NET profit before you’ve paid the tax man and any interest you owe to the bank).

(chart assumes a product cost of 25% of sale price)

 

It is incredibly important to make sure that all of your sales are classified with the correct VAT rate for two main reasons:

  1. To avoid paying over more VAT than you should, and
  2. To avoid under declaring VAT and ending up with an HMRC investigation.

In true HMRC fashion, the manual surrounding VAT on Food supplies (VFOOD5220) isn’t all that helpful and HMRC don’t give a stringent enough list on what products and services are subject to what VAT Rate. Some of the key mistake that business owners generally make are:

The best way to ensure that you don’t fall foul of any VAT traps is to speak to an accountant or tax advisor. You should also ensure that you’ve got a decent till system in place to help you record and monitor you sales levels- preferably one that links into accountancy software to help automate the process.

 

What Can You do?

I’d always start with two things- a business plan and a budget and in that order. Your business plan doesn’t have to be anything magical and you don’t need to go along with the whole “where do I see myself in 10 years?” lark. A business plan is about setting goals, (whether personal or professional) and working through how you’re going to achieve them- you want to buy a house in 5 years time? Ok, well how much money does the business need to make in order to provide you with a wage and dividends to be able to afford the house that you’re after? That’s where the budget comes in.

A good enough accountant will be able to turn your non-financial hopes and dreams into something measurable. Your budget not only gives you something to work towards, but it also gives you something to measure performance against and it is an invaluable tool. Your budget should be continuously revised month-on-month to account for any changes in the business and you should aim to have your next 12 months laid out in front of you. By utilising your budget you’ll be able to include all of these increased costs that we’ve talked about above and get a really good picture of:

  1. What your breakeven point is (how much money you need to make to cover all your costs).
  2. What your profit level looks like with the increased employment, supplier, energy and VAT costs.
  3. What your GP and Wage % look like

Your budget will also help you determine whether or not you’ll need to increase your selling price or reduce your stock and labour costs or even change business model all together!

This article/blog/content was written by Gareth from Evans and Co Hospitality Accountants. Gareth spent 12 years in the industry before deciding to put down his knives and buy a swivel chair. He’s since helped dozens of hospitality businesses increase their bottom line whilst ensuring that they’re compliant with tax regulations.

If you think that Gareth may be able to help you and your business, then click here for a no obligation chat.

Alternatively, you can contact Gareth on 07961789505 or info@evansandco.uk.

 

 

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