VAT cash accounting is one of the most common methods businesses can use to alleviate the pressure on cash flow and simplify the record keeping.
Tax must be managed effectively, and It is important for any business, small, medium or big to ensure that this is done correctly. VAT cash accounting limits are currently £1.35 million at the time of writing.
So, what is the government’s VAT cash accounting scheme – its benefits, its limits, and how do you decide if this system is right for your business?
VAT cash accounting is a scheme where businesses are permitted to account for VAT by reference to actual payments they receive and pay.
In other words, the VAT that your customers pay you, you only have to pay to HMRC, and any VAT you can reclaim back on your purchases when you pay your suppliers.
In contrast to standard VAT accounting which records VAT accumulated based on invoice date, irrespective of whether payments have been made or received, the payment is fed into this system first and this triggers the recording of the accounting book.
How does VAT cash accounting work?
Under the scheme:
- You only pay VAT on sales once the customer has paid its invoice
- The only time you can get back VAT on purchases is once the supplier has been paid
For example, if you issue an invoice in January but don’t receive payment until March, the VAT is accounted for in your March VAT return.
Similarly, if you receive an invoice in January but pay the supplier in February, the VAT reclaim happens in your February VAT return.
This approach can be particularly beneficial for businesses dealing with late-paying customers, as it ensures that VAT is not paid upfront on money not yet received.
VAT cash accounting is not the same as the VAT flat rate scheme – find out more about that here.
Eligibility for the scheme
To use this scheme, your business must meet certain criteria:
- VAT registration: You must be VAT registered.
- Annual turnover limits: The cash accounting VAT threshold is currently £1.35 million.
Once enrolled, you can continue using the scheme until your turnover exceeds the exit threshold, which is set at £1.6 million.
Businesses with a turnover near these VAT cash accounting limits should monitor their revenue closely to ensure ongoing compliance.
Who can benefit from VAT cash accounting?
This scheme is particularly useful for businesses that:
- Have customers who take time to settle invoices.
- Operate in industries with unpredictable cash flow.
- Regularly issue credit to customers.
By only paying VAT after receiving payments, businesses can avoid the cash flow strain caused by paying VAT on unpaid invoices.
On the other hand, businesses with prompt-paying customers or those that make substantial zero-rated sales may find the benefits less pronounced.
Advantages of VAT cash accounting
Potential advantages include:
1. Improved cash flow: The most favourable feature of the scheme is the ability to postpone the payment of VAT to the date on which money is received. This is extremely useful for small businesses and startups that barely survive on the cash flow basis, so this can be really helpful.
2. Reduced risk of bad debt: With standard VAT accounting it creates the problem of a business paying VAT on sales in the event that the customer does not pay. With cash accounting, if you receive cash, you pay VAT, so you have no risk there.
3. Simplified record-keeping: VAT accounting through actual bank transactions makes it easy to track VAT. That means less of a wait to save up VAT returns and even less chance of getting it wrong.
We also recommend reading our guide on ways for businesses to pay less VAT.
Potential drawbacks
The scheme has obvious benefits, but it’s not an appropriate approach for all businesses.
1. Limited VAT reclaims: Purchases are reclaimed on VAT at the point the supplier is paid under this scheme. Businesses who are coming in at extended terms might find their VAT recovery delayed.
2. Turnover restrictions: For growing businesses, the cash accounting VAT threshold of £1.35 million may restrict eligibility. If companies are approaching this turnover they may have to look at alternative VAT schemes.
3. Unsuitability for certain sectors: The benefits of cash accounting are less evident for businesses whose revenues are paid very quickly into their bank accounts, and that includes retail operations since VAT payments could occur very quickly in either method.
Managing VAT cash accounting
Joining the VAT cash accounting scheme is straightforward:
- Ensure your business meets the eligibility criteria.
- Inform HMRC by adopting the scheme in your next VAT return.
- Adjust your accounting systems to track VAT based on payments received and made, rather than invoice dates.
We recommend consulting an accountant or VAT specialist to ensure the scheme is implemented correctly.
To manage VAT cash accounting effectively:
- Keep accurate records of payments with others.
- Make bank statements and invoices and receipts reconcilable regularly.
If your business turnover exceeds the exit threshold of £1.6 million or if you find the scheme no longer suits your needs, you must switch to a different VAT accounting method.
When exiting, you’ll need to adjust your records to ensure all outstanding VAT liabilities and claims are accounted for correctly. Check here – how long should I keep accounting records?
Businesses must weigh these factors against their cash flow patterns and operational requirements to make an informed decision. Find out here – what is bad debt in accounting?
Final thoughts: VAT cash accounting
Among other things, the scheme is attractive to small businesses due to flexibility and cash flow benefits. However, it’s essential to:
- Monitor turnover to ensure that you stay below the cash accounting VAT threshold.
- Learn what happens when sales generate extra VAT and records are kept until the end of the year to reclaim it.
- It is now time to go through the scheme again to check that the scheme is still beneficial.
However, small businesses can still make best use of the scheme and avoid the commonly made mistakes by consulting with a VAT expert or an accountant.
VAT cash accounting offers a practical solution for businesses looking to improve cash flow and simplify VAT management. By only accounting for VAT on payments received and made, businesses can avoid the strain of paying VAT on unpaid invoices.
However, the scheme isn’t a one-size-fits-all solution. Careful consideration of turnover limits, cash flow patterns, and sector-specific needs is essential before deciding to adopt this approach.
With proper implementation and regular monitoring, it can be a valuable tool for maintaining financial stability and compliance. For tailored advice, seeking professional guidance is always a smart step.
We hope you found this article useful. For other informative guides, take a look at our blog – recently we answered two common questions… How is corporation tax calculated and what is petty cash?
The team at Accountants East London have over 30 years of experience. For any advice or to find out more about our services, please contact us.
