Cash Accounting for VAT: could it help your cashflow?

If you are tempted to scroll on or tune out on seeing VAT in this week’s title, please think again! Did you know that a VAT mechanism exists to mitigate late payment risk and it’s called Cash Accounting for VAT. This newsletter covers what it is and who can use it,  and is written with help from a qualified accountant.

Why are we talking about VAT?

A couple of weeks ago, I received an email from a small business owner suggesting that payment of VAT was creating an issue as there are times when VAT has to be paid before the business has received payment for work delivered. I accepted the context of this double whammy impact to cashflow and raised it with colleagues in HMRC to ask for a view. The response was helpful and pointed to Cash Accounting for VAT as a possible mitigation scheme.

Introducing Cash Accounting for VAT

It is a scheme that enables businesses to account for VAT only when payment is made or received, thereby aligning VAT liability with cash flow. The threshold for eligibility is £1.35 million projected turnover, and the scheme is available to any VAT-registered business meeting basic compliance criteria. While it has limitations—such as exclusions for certain transactions and reduced benefit where customers pay promptly—it does address the core issue of not having a payment gap of having to pay out before taking payment in.

I turned to the excellent Lucy Cohen, Founder & CEO of accounting firm, Mazuma, and President of AAT to ask for her qualified view and ‘on the ground’ perspective. This is her comprehensive response:

‘Cash accounting provides automatic protection against bad debts and slow payers. If the cash has not arrived, the VAT is not due. For businesses that invoice on credit terms, that is a meaningful safeguard.

It reduces the need for businesses to act as short-term lenders to both their customers and HMRC. Of course, what it does not do is change late payment behaviour but it does stop VAT from compounding the damage caused by late payment.

There is no definitive, real-time official data on how many businesses use the Cash Accounting Scheme. Unlike VAT registration itself, businesses do not have to formally opt in or out via a separate registration process when choosing their accounting method, which makes precise tracking difficult.

That said, HMRC-commissioned research into VAT behaviours has suggested that fewer businesses report using the Cash Accounting Scheme, compared with much higher take-up of schemes such as the Flat Rate Scheme among small businesses who are eligible. That puts it in minority use, despite its clear cash flow advantages.

There are some important constraints that limit how far cash accounting can go.

First, it only applies to VAT-registered businesses. Fewer than half of UK businesses are VAT registered. Mandatory VAT registration only applies once turnover exceeds £90,000, and while some businesses register voluntarily, many of the very smallest businesses never enter the VAT system. For them, cash accounting is irrelevant.

Second, some sectors are structurally disincentivised from registering for VAT in the first place. Hospitality is a good example. Businesses selling directly to consumers often cannot recover VAT from customers without raising prices, so VAT registration itself becomes a commercial disadvantage.

Third, cash accounting cuts both ways. While it delays VAT payments on sales, it also delays VAT reclaims on purchases. You can only reclaim input VAT once you have paid your supplier. For businesses that invest heavily in equipment or software, or that are regularly in a VAT repayment position, this can weaken the overall benefit.

My overall take is that Cash Accounting for VAT is a genuinely helpful tool for VAT-registered businesses that invoice on credit terms and are usually net VAT payers. It provides automatic protection against unpaid invoices and smooths cash flow at exactly the point many small businesses feel the most strain.’

Potential to scale the scheme

Based on this fair summary of the scheme, we are engaging with HMRC on discussions around a potential increase in the eligibility threshold that would enable more firms to benefit and reduce the amount of VAT being funded out of working capital during growth phases.

If you are a VAT registered business that meets the eligibility criteria, speak to an accountant re the potential benefits the scheme could deliver for you.

Thanks to Lucy for the excellent input.