What are the benefits of calculating VAT on a cash basis?

by | Mar 9, 2020 | VAT

VAT has always been a love hate relationship for business owners.

They’ll love the initial increase in cashflow, but then hate when they have to pay the VAT to the HMRC, and whilst most businesses registering for VAT will default onto the standard VAT accounting scheme, there is another method that could save your businesses cashflow troubles.

Voluntarily registering for VAT comes with a whole host of benefits, especially if you have ambitions to grow your business in the future. It means you can reclaim VAT on your business costs, and can also help to give the appearance of a bigger and better established company, which can help inspire buyer confidence.

It is for these reasons that many businesses choose to register voluntarily, but remember, once your turnover reaches a certain threshold (over £85,000) you will be legally required to register for VAT.

VAT registration however comes a set of responsibilities. You’ll be responsible for calculating your own VAT, either manually or through software like Xero (though your accountant can do this for you – but you will ultimately be responsible for ensuring it’s correct). You’ll also be responsible for its accurate accounting.

To do this, there are two ways to choose from, accrual accounting and cash accounting. It’s important to know that both have their pros and cons, which we’ll talk about next.

What is cash accounting for VAT?

The main difference between accrual and cash accounting is at how the VAT is calculated.

Cash accounting means you’re calculating VAT when you pay it to your suppliers, or receive it from your customers, whereas accrual accounting means you calculate (and pay it to the HMRC) when you issue an invoice to a customer, or receive an invoice from your suppliers, not when you make or receive the payment.

When we refer to the term ‘cash’, it does also refer to card payments, bank transfers, direct debits, standing orders and cheques, not just physical cash.

It is important to note that this is not applicable for goods bought or sold under finance agreements (such as leases or hire purchase agreements), conditional sale agreements, supplies of goods invoiced in advance of delivery, or where a payment isn’t due for more than 6 months after the invoice date.

Why is cash accounting better?

Cash accounting can bring a whole range of benefits to a business.

  1. It makes calculating VAT much simpler – most business owners find it easier to keep track of payments and receipts than they do invoices.
  2. Cashflow – it has a positive impact on cashflow because you’re not having to pay the VAT to the HMRC before you’ve even been paid by your customer.
  3. Immediate bad debt relief – if no payment is received, no VAT is paid to the HMRC.

Good vs Bad

What are the bad points?

As with everything, there are always downsides.

  1. Delayed input VAT recovery – You can’t recover the VAT you suffer from your suppliers until you pay them.
  2. Impact for net repayment businesses – if you’re a new business and need to invest in significant equipment, you should delay signing up so that you can reclaim the VAT on the equipment before you need to charge VAT to your customers by way of a backdated claim.

What else do I need to know?

Joining the scheme

From 1 April 2007 a business can join the scheme if it believes taxable sales in the next 12 months will not exceed £1,350,000, and provided that it:

  • is up to date with VAT returns • has paid over all VAT due or agreed a basis for settling any outstanding amount in instalments
  • has not in the previous year been convicted of any VAT offences.

All standard and zero-rated supplies count towards the £1,350,000 except anticipated sales of capital assets previously used within the business. Exempt supplies are excluded.

Leaving the scheme

Once annual turnover reaches £1,600,000 the business must leave the scheme immediately.

When a business leaves the scheme, VAT is due on all supplies on which it has not already been included on the VAT return. However outstanding VAT can be accounted for on a cash basis for a further six months after leaving the scheme.

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