If your business is VAT registered, you may have a choice between using standard VAT accounting and the VAT Cash Accounting Scheme.
The main difference between the two methods is timing.
Under standard VAT accounting, VAT is generally accounted for by reference to the tax point of the transaction, which will often be linked to when an invoice is issued or received. Under VAT Cash Accounting, you generally account for VAT on sales when your customers pay you and reclaim VAT on purchases when you pay your suppliers.
That difference can have a significant impact on cash flow, particularly if your customers take a long time to pay.
So, when comparing VAT Cash Accounting vs Standard VAT Accounting, which is better for your business?
In this guide, we explain how both methods work, their advantages and disadvantages, who can use VAT Cash Accounting and when it might make sense to switch.
What is standard VAT accounting?
Under standard VAT accounting, VAT is normally included on your VAT return based on the tax point of the transaction.
Put very simply, this usually means accounting for VAT when you issue a sales invoice, rather than waiting until your customer pays you.
Similarly, you can normally reclaim VAT on eligible business purchases based on the supplier invoice, even if you haven’t paid the supplier yet, provided you hold the appropriate VAT evidence.
|
Example Suppose you issue a customer with an invoice for: |
|
| Net sale | £10,000 |
| VAT | £2,000 |
| Total | £12,000 |
| You issue the invoice in March, but your customer doesn’t pay you until May. | |
If the invoice falls within your March VAT quarter, under standard VAT accounting the £2,000 output VAT would normally be included on that VAT return.
You could therefore have to pay HMRC the VAT before you’ve received the money from your customer.
For businesses that are paid quickly, this may not be a significant issue. However, if you offer 30, 60 or 90-day payment terms, it can place additional pressure on your business cash flow.
What is the VAT Cash Accounting Scheme?
The VAT Cash Accounting Scheme works differently.
Instead of accounting for VAT primarily when invoices are issued and received, you generally account for VAT based on when money is actually received and paid.
Using our example above, if the customer didn’t pay the £12,000 invoice until May, the £2,000 output VAT would generally not be accounted for until the VAT period covering the May payment.
This can make cash accounting particularly attractive to businesses with slow-paying customers.
There is, however, a flip side to this.
Under cash accounting, you generally cannot reclaim VAT on your purchases until you have paid your supplier. Therefore, cash accounting delays both the VAT you pay to HMRC on your sales and the VAT you recover on your costs.
Who can use cash accounting?
The VAT Cash Accounting Scheme is optional and is aimed primarily at smaller businesses.
You can usually join the scheme if your estimated VAT-taxable turnover for the next 12 months is no more than £1.35 million.
However, once you are using the scheme, you can generally remain within it until your taxable turnover exceeds £1.6 million, subject to the detailed scheme rules.
There are some circumstances where a business cannot use the scheme, including certain situations where it is not up to date with its VAT returns or VAT payments.
You don’t normally need to make a separate application to HMRC before starting to use cash accounting. However, your accounting records need to clearly show that the scheme is being operated correctly.
How do the two VAT accounting methods compare?
When comparing VAT Cash Accounting vs Standard VAT Accounting, the main differences can be summarised as follows:
| Standard VAT accounting | VAT Cash Accounting | |
|---|---|---|
| VAT on sales | Usually accounted for based on the tax point | Usually accounted for when payment is received |
| VAT on purchases | Usually reclaimed based on the tax point | Usually reclaimed when the supplier is paid |
| Slow-paying customers | You may pay VAT before receiving payment | VAT is generally delayed until you are paid |
| Supplier credit | You may recover VAT before paying suppliers | Recovery normally waits until payment |
| Bad debts | VAT bad debt relief may need to be claimed | VAT generally hasn’t been paid if the customer hasn’t paid |
| Turnover limit | No equivalent cash accounting limit | Normally £1.35m to enter the scheme |
| Main benefit | Earlier recovery of VAT on unpaid purchases | Potential cash-flow improvement |
What are the advantages of cash accounting?
You don’t normally have to fund the VAT before your customer pays
This is probably the biggest advantage.
Under standard VAT accounting, you can find yourself paying VAT to HMRC on an invoice that your customer hasn’t paid.
By contrast, under cash accounting, the VAT is generally accounted for when you receive payment.
Therefore, for businesses offering customers credit, this can provide a useful cash-flow advantage.
Slow-paying customers become less of a VAT problem
If a customer takes several months to pay an invoice, you generally won’t have paid the output VAT to HMRC while you’re still waiting to receive payment.
This can be particularly beneficial for businesses that regularly have significant amounts outstanding from customers.
Bad debts are more straightforward from a VAT perspective
Under standard VAT accounting, you may have already accounted for VAT to HMRC before discovering that a customer isn’t going to pay you.
While VAT bad debt relief may eventually be available, specific conditions apply.
Conversely, under cash accounting, if your customer never pays you, you generally won’t have accounted for the VAT on the unpaid amount in the first place.
What are the disadvantages of cash accounting?
However, cash accounting isn’t automatically more beneficial simply because it delays the VAT due on your sales.
Delayed VAT recovery on purchases
Under cash accounting, you normally have to wait until you pay a supplier before recovering the VAT.
This can make the scheme less attractive if your business has substantial purchases bought on credit.
For example, if you buy significant amounts of stock or equipment and your suppliers give you generous payment terms, standard VAT accounting may allow you to recover the VAT before you’ve actually paid for those purchases.
Limited benefit if customers pay quickly
For example, if you run an e-commerce business and customers generally pay by card at checkout, there may be very little timing difference between making the sale and receiving payment.
Equally, the same can apply to businesses where invoices are routinely settled immediately or within a few days.
In these circumstances, cash accounting may provide little practical cash-flow advantage.
VAT Cash Accounting still requires accurate bookkeeping
Cash accounting relies on knowing when invoices have actually been paid.
Modern accounting software makes this much easier, but complications can arise where businesses have:
Accurate and effective bookkeeping remains important whichever VAT accounting method you use.
Which VAT accounting method is more beneficial?
When considering VAT Cash Accounting vs Standard VAT Accounting, there isn’t one method that will be better for every business.
Ultimately, the right choice depends largely on how quickly your customers pay you compared with how quickly you pay your suppliers.
Cash accounting can be particularly attractive if you:
Conversely, standard VAT accounting may be more beneficial if:
An example of when cash accounting can be advantageous
Suppose a consultancy invoices customers £100,000 plus £20,000 VAT during a VAT quarter.
At the end of the quarter, only half of those invoices have actually been paid.
Ignoring other transactions for simplicity, under standard VAT accounting the business may have to account for the full £20,000 of output VAT, despite having only received half of the money from its customers.
Under cash accounting, only the VAT relating to the payments actually received would generally be accounted for at that stage.
That could mean accounting for £10,000 rather than £20,000 of output VAT in that VAT period.
The other £10,000 isn’t avoided. It is simply accounted for later when the customers pay.
But that timing difference can prove valuable for a growing business.
What if your business regularly receives VAT refunds?
Cash accounting can sometimes work against businesses that regularly recover VAT from HMRC.
Suppose your business purchases expensive equipment or holds substantial stock and your suppliers offer generous payment terms.
Under standard VAT accounting, you may be able to reclaim the VAT on the supplier invoice before you’ve actually paid it.
By contrast, under cash accounting, VAT recovery would normally be delayed until payment is made.
This is why you should consider the timing of both output VAT on sales and input VAT recovery on purchases before deciding whether VAT Cash Accounting will provide a cash-flow benefit.
It isn't simply a question of how quickly your customers pay you.
Can you switch from standard VAT accounting to cash accounting?
Yes, provided your business meets the conditions for joining the scheme.
Alternatively, you can leave cash accounting and return to standard VAT accounting.
However, changing VAT accounting methods requires careful consideration.
You need to ensure VAT isn’t accidentally accounted for twice or missed altogether when switching between schemes. There are also specific rules covering transactions that are outstanding when you enter or leave the scheme.
If you’re considering changing methods, it’s prudent to review your outstanding sales and purchase invoices prior to making any decision.
Does cash accounting affect invoicing?
Cash accounting changes when VAT is accounted for on your VAT return. It doesn’t remove the normal compliance surrounding VAT invoices, records and tax points.
Your business still needs appropriate VAT records and should continue to issue valid VAT invoices where required.
Cash Accounting vs the VAT Flat Rate Scheme: what’s the difference?
The VAT Cash Accounting Scheme and the VAT Flat Rate Scheme are two entirely separate VAT schemes that operate in different ways.
VAT Cash Accounting primarily changes the timing of when VAT is paid to or reclaimed from HMRC. Broadly speaking, you account for VAT on sales when your customers pay you and reclaim VAT on purchases when you pay your suppliers.
By contrast, the Flat Rate Scheme changes how your VAT liability is calculated. Eligible businesses generally apply a fixed percentage, determined by their business sector, to their VAT-inclusive turnover rather than calculating the VAT due to HMRC in the usual way.
The schemes also have different eligibility criteria, turnover limits and rules. Importantly, some businesses can use the Flat Rate Scheme and VAT Cash Accounting together, provided they meet the relevant conditions.
Should you switch to cash accounting?
When deciding between VAT Cash Accounting vs Standard VAT Accounting, one of the most important factors is how quickly your customers pay you compared with how quickly you pay your suppliers.
A useful starting point is to look at your trade debtors and trade creditors.
If your business regularly has significant amounts outstanding from customers, VAT Cash Accounting may provide a worthwhile cash-flow advantage. Instead of potentially paying output VAT to HMRC before you have collected it from your customers, the VAT is generally accounted for when payment is received.
However, there is another side to the calculation. Under VAT Cash Accounting, you normally have to wait until you have paid your suppliers before recovering the associated input VAT.
This means that if your customers tend to pay you quickly but you benefit from extended payment terms from suppliers, standard VAT accounting may actually be more advantageous.
For businesses where customers and suppliers are both paid relatively quickly, there may be little practical difference between the two methods.
The key point is that VAT Cash Accounting is primarily a cash-flow management tool, not a tax-saving scheme. Over time, broadly the same amount of VAT will normally be accounted for. The main difference is the timing of when VAT is paid to HMRC and when input VAT can be recovered.
Need help deciding which VAT accounting method is right for your business?
Choosing between VAT Cash Accounting and standard VAT accounting depends on how your business operates, including when your customers pay you, when you pay your suppliers and the overall effect on your cash flow.
If you are reviewing your VAT arrangements, you may also find our guides on VAT registration , the VAT Flat Rate Scheme and VAT for e-commerce businesses useful. These cover some of the other VAT and bookkeeping issues that commonly affect small businesses.
At The Friendly Accountants, we advise small businesses on VAT, bookkeeping and cloud accounting, including Xero and FreeAgent.
If you are unsure whether VAT Cash Accounting would benefit your business, we can review your circumstances and explain the practical implications of the different options.
You can explore our other VAT and accounting guides or, if you would like to discuss how we could help your business, complete our Business Questionnaire and a member of our team will be in touch.