VAT cash accounting scheme: is it right for your business?

The VAT cash accounting scheme can help some businesses manage cash flow by paying VAT when customers pay, rather than when invoices are issued. However, it also affects when you can reclaim VAT on purchases, so it is worth checking whether the scheme suits the way your business actually works.

What is the VAT cash accounting scheme?

Under standard VAT accounting, you normally account for VAT based on invoices. That means you may have to pay VAT to HMRC before a customer has actually paid you.

Imagine you issue an invoice for £10,000 plus VAT in March. The VAT on that invoice – £2,000 – falls into the VAT return for the period covering March. But if the customer takes 60 days to pay, you could find yourself handing over £2,000 to HMRC before the money arrives in your bank account.

The VAT cash accounting scheme changes this. Under cash accounting, you account for VAT based on payments received and payments made – not invoices issued and received. So you pay VAT on sales when your customer pays you, and you reclaim VAT on purchases when you have paid your supplier.

How can VAT cash accounting help your cash flow?

If your customers are slow to pay, the scheme can make a real difference. Your VAT bill becomes more closely aligned with the cash actually sitting in your business. You are less likely to be paying HMRC money you have not yet received.

There is also a secondary benefit. Under the scheme, bad debts are automatically relieved. If a customer never pays, you never account for the VAT. This saves you the extra step of making a separate bad debt relief claim.

One important point to keep in mind: the scheme does not reduce the VAT you owe. It changes when you have to pay it.

When might the VAT cash accounting scheme not be suitable?

Cash accounting is not the right choice for every VAT-registered business. It may be less helpful – or even less favourable – in certain situations.

If your customers generally pay on time or upfront, the cash-flow advantage largely disappears. The same applies if your business regularly receives VAT repayments from HMRC – under cash accounting, those repayments may come through more slowly.

There is also a catch on the purchase side. Because you only reclaim input VAT when you have paid your suppliers, if you buy stock or equipment on extended credit terms, you could end up waiting longer to recover that VAT than you would under standard accounting.

As with most VAT decisions, context matters. The right scheme depends on your turnover, your customers, your suppliers, your payment patterns and how you manage cash day to day. It is worth taking advice before switching.

Who can use the VAT cash accounting scheme?

To use the VAT cash accounting scheme, your business must normally meet these conditions:

• The business must be VAT registered.
• Estimated VAT taxable turnover must be £1.35 million or less in the next 12 months.
• VAT returns need to be up to date, and any VAT owed should either be paid or covered by an arrangement agreed with HMRC.
• The business must not have committed a VAT offence in the last 12 months, for example VAT evasion.
• Cash accounting cannot be used at the same time as the VAT Flat Rate Scheme.

You must leave the scheme if your VAT taxable turnover exceeds £1.6 million. Some transactions – including hire purchase and credit sale arrangements – must also use standard VAT accounting regardless of which scheme you are on.

Do you need to tell HMRC before using the scheme?

If you are eligible, you do not normally need to notify HMRC before you start using the VAT cash accounting scheme. You simply begin at the start of a VAT accounting period.

That said, joining is not something to do without preparation. Your records and VAT return calculations need to reflect the change accurately from day one. Good bookkeeping is essential.

You can leave the scheme at any time, though you would normally do so at the end of a VAT accounting period. When you leave, you must account for any VAT on outstanding invoices – even if customers have not yet paid. HMRC does allow this to be reported and paid over six months in most cases, although you may have to pay straight away if your VAT taxable turnover exceeded £1.35 million in the last three months.

VAT cash accounting, annual accounting and the Flat Rate Scheme

The VAT cash accounting scheme is one of several VAT accounting schemes available to eligible businesses. Three common options are:

• Cash Accounting Scheme. VAT is based on when customers and suppliers are paid, not when invoices are issued.
• Annual Accounting Scheme. You submit one VAT return per year and make advance payments throughout the year. Available to businesses with VAT taxable turnover of £1.35 million or less.
• Flat Rate Scheme. VAT is calculated as a fixed percentage of gross turnover, which simplifies record-keeping. This scheme has a lower turnover limit of £150,000 excluding VAT, and cannot be combined with cash accounting.

THP has a separate guide to the VAT Flat Rate Scheme if you want to explore that option. Each scheme has different implications for cash flow, VAT records and your VAT returns, so it pays to compare them properly before making a decision.

How THP can help

Choosing the right VAT scheme is not just a compliance question – it can have a meaningful impact on your cash flow throughout the year. THP can review how and when money comes into and leaves your business, then compare the VAT cash accounting scheme with annual accounting, the Flat Rate Scheme and standard VAT accounting.

We also prepare VAT returns and help clients stay on top of their obligations to HMRC – including businesses navigating Making Tax Digital requirements.

Not sure which VAT scheme is right for your business?

THP can review your turnover, payment patterns and VAT records, then advise whether the VAT cash accounting scheme is the best fit. We can also offer a VAT Returns Service to help you stay compliant with HMRC. Get in touch with one of our friendly accountants today – they’d be delighted to help you.