VAT Cash Accounting Scheme: A Simple Guide for Small Business

Managing cash flow is one of the biggest challenges for small businesses—especially when you’re waiting on customer payments but still owe VAT to HMRC. That’s where the VAT Cash Accounting Scheme comes in.

In this article, we will introduce VAT and the cash accounting scheme, examine how it might benefit a business, outline the rules, and provide examples.

An Introduction to VAT

Value Added Tax (VAT) is a tax charged on most goods and services sold in the UK. It’s paid by the end consumer, but collected and reported by businesses on behalf of HMRC (HM Revenue & Customs).

If your business is VAT-registered, you’ll need to:

• Charge VAT on your sales
• Pay VAT on business purchases
• Submit regular VAT returns to HMRC
• Keep digital records under Making Tax Digital (MTD) rules

VAT applies to most UK businesses once their taxable turnover exceeds £90,000 in a 12-month period. However, even smaller businesses can register voluntarily.

There are different VAT rates, schemes, and rules depending on what you sell and who you sell to—so understanding the basics is crucial to staying compliant and managing your cash effectively.

What is the VAT Cash Accounting Scheme?

This scheme allows VAT-registered businesses to pay only when they receive payment from customers, rather than when they issue an invoice. It can make a big difference to your cash flow, particularly if you deal with late payers.

It allows businesses to:

• Pay VAT to HMRC only when customers pay you
• Reclaim VAT on purchases only when you’ve paid your suppliers

It differs from the standard VAT method, which records transactions based on invoice dates, rather than actual payments.

How the Cash Accounting VAT Scheme Works

Under the Cash Accounting Scheme, you report VAT based on when money actually changes hands, not when invoices are issued.

Here’s how it works:

• You charge VAT on your sales as usual—but you only pay it to HMRC once your customer pays you.
• You reclaim VAT on your business purchases only when you’ve paid your supplier.

Key Points:

• You submit quarterly returns as usual.
• You must keep proper records of when payments are received and made, not just VAT invoices.
• It helps avoid cash problems, especially if customers pay late.

Benefits of using the Cash Accounting VAT Scheme

There are benefits of a business using the scheme, including:

• Improved Cash Flow – You only pay VAT when your customer pays you, so you’re not out of pocket while waiting on late payments.
• No VAT on Unpaid Invoices – If a customer doesn’t pay, you don’t owe VAT on that sale (unlike standard VAT accounting, where it’s due once invoiced).
• Simplified Reclaiming – You only reclaim VAT on purchases after you’ve paid—making it easier to match VAT to real cash movements.
• Easier Budgeting – It is based on actual cash in and out, it’s easier to manage your business finances and forecast accurately.
• Ideal for Small Businesses – Especially useful when offering credit terms where customers don’t settle immediately.

There are also a few disadvantages to using the scheme.

• Delayed VAT Reclaims – You can only reclaim VAT on purchases once you’ve paid the supplier
• Not Always Ideal for Cash-Upfront Businesses – If customers pay immediately (e.g. retail), the scheme offers little benefit
• Eligibility Limits – You can only join if your annual VAT-taxable turnover is £1.35 million or less. If it goes over £1.6 million, you must leave the scheme.

Who can use the Scheme?

The Cash Accounting VAT Scheme is available to most VAT-registered businesses in the UK, as long as their estimated taxable turnover (excluding VAT) is £1.35 million or less in the next 12 months. This includes most sole traders, partnerships, and small limited companies that provide goods or services on credit or experience delays in receiving customer payments.

How to Join the VAT Cash Accounting Scheme

You don’t need to apply formally to HMRC to join the VAT Cash Accounting Scheme. If your business is eligible, you can simply start using the scheme from the beginning of your next VAT accounting period.

When you submit your next return, calculate your VAT based on the payments received and made, rather than the invoice dates. It’s essential to use the scheme consistently—you can’t switch between cash and standard methods from one return to the next.

Record Keeping Requirements

Keeping clear and consistent records helps avoid mistakes, ensures you’re reclaiming the correct VAT, and keeps you fully compliant with HMRC rules. Good record-keeping is essential when using the VAT Cash Accounting Scheme, as it accounts for VAT based on actual payments, not invoice dates.

You must keep accurate, up-to-date records showing:

✅ Sales Records

• Date you received payment from the customer
• Invoice number and details
• Amount received
• VAT rate charged
• Method of payment (e.g. bank transfer, card)

✅ Purchase Records

• Date you paid your supplier
• Supplier invoice details
• Amount of payment
• VAT amount you’re reclaiming
• Proof of payment (e.g. bank statement or receipt)

💻 Digital Records (MTD-Compliant)

Under Making Tax Digital (MTD), you must keep these records digitally using MTD-compatible software (e.g. Xero, QuickBooks, or bridging software if using spreadsheets). Your records must include digital links between data and returns.

📅 Keep Records for at Least 6 Years

HMRC requires you to retain all records for a minimum of six years, in case of inspections or audits.

Keeping clear and consistent records helps avoid mistakes, ensures you’re reclaiming the correct VAT, and keeps you fully compliant with HMRC rules.

Switching In or Out of the Scheme

✅ How to Join the Scheme

You don’t need to formally apply to HMRC. If you’re eligible, you can start using the scheme from the beginning of your next VAT accounting period.

Steps to join:

1. Ensure you’re eligible (turnover under £1.35m and no disqualifications, such as recent VAT offences).
2. Choose the start date—it must be the beginning of a VAT period.
3. Start keeping records based on actual payments (not invoice dates).
4. Note on your VAT return that you’re using the Cash Accounting Scheme.
5. Update your accounting software or notify your accountant.

❌ How to leave the Scheme

You must leave the scheme if:

• Your VAT-taxable turnover exceeds £1.6 million
• You choose to leave voluntarily
• HMRC tells you to leave (e.g. for non-compliance)

Steps to leave the scheme:

1. Choose an exit date, which must also be the start of a VAT period.
2. Switch back to standard VAT accounting (based on invoice dates).
3. Make adjustments for any unpaid invoices or unclaimed VAT and pay any outstanding VAT within 6 months.
4. Update your bookkeeping system and inform your accountant.

Other Schemes to Consider

If the Cash Scheme isn’t the right fit, HMRC offers other schemes to help simplify VAT:

Flat Rate Scheme

Under the flat rate scheme you pay a fixed percentage of your turnover on each sale and purchase. Ideal for businesses with minimal expenses and straightforward operations.

Annual

Pay a fixed amount per quarter and submit just one VAT return per year. Ideal for businesses with steady invoicing who want less admin.

Retail

Designed for businesses with numerous small or mixed-rate sales, such as shops or cafes.

Each scheme has its own rules and benefits. The right one depends on your business type, turnover, and how you manage your finances. If you are unsure which is best for your business, speak to an accountant for advice.

Cash Accounting VAT Scheme Conclusion

The VAT Cash Accounting Scheme is helpful if you want to improve cash flow and avoid paying VAT on unpaid invoices. By basing VAT on actual payments rather than invoice dates, it offers a more manageable way to stay on top of your obligations—mainly if you deal with delayed customer payments.

While it won’t suit every business, it can be an excellent fit for service-based or credit-heavy businesses with steady turnover of less than £1.35 million.

Further Reading

HMRC VAT Cash Accounting