For the vast majority of goods and services we buy for ourselves or for our businesses, one-sixth of the value of each of our purchases will be for Value Added Tax.
In this article, An Accounting Gem
- describes what VAT is and when you need to register for it
- the different VAT schemes you can apply to join and under what circumstances
- a comparison of cash accounting VAT with accrual (or standard) VAT
What is VAT?
When a business’s turnover exceeds £85,000 per year (or it looks likely to exceed £85,000 per year) on the sale of goods and services which are not VAT-exempt, its owners must register the company for Value Added Tax (VAT).
You can choose to register for VAT if your turnover is below that level if you choose. There may be advantages to doing so if you sell primarily to VAT-registered businesses, however, if you sell a relatively high gross margin product or service to consumers, registering for VAT may put your company at a competitive disadvantage.
When registered for VAT, you must charge your clients VAT on all of your invoices – the VAT you charge is your “output VAT”.
At the same time, when your VAT-registered suppliers send you an invoice on which VAT is payable, this is called your “input VAT”.
The VAT you pay to HMRC (or they pay to you) is the total value of the output VAT you’ve charged over a given period of time minus the total value of the input VAT you’ve paid. The normal period of time between VAT bills is three months.
Which VAT schemes are there?
There are multiple VAT schemes available for small-to-medium-sized businesses to choose from and An Accounting Gem will help you select the correct scheme for you.
- VAT cash accounting is best for businesses which invoice over 30 days or longer and which turn over more than £150,000 and less than £1.35m a year
- VAT accrual accounting is best for businesses which invoice over very short periods or take the money at the point of sale and turn over more than £150,000 and less than £1.35m a year
- Flat rate VAT is a simpler form of VAT for companies turning over £150,000 or less
- VAT retail scheme is a special retail-focused version of the flat rate VAT scheme offering greater flexibility for shops selling tangible consumer products like clothing, white goods, and more.
- VAT margin scheme is the best choice for companies dealing in second-hand goods, antiques, art, and collectors’ items
- VAT annual accounting scheme is a cash flow friendly version of VAT where you know the entire amount of VAT in advance payable for the following year, the dates (either monthly or quarterly) you make your VAT payment, and how much each payment will cost.
Your business needs change as time goes on and as your company experiences periods of growth and expansion. An Accounting Gem will advise you if your circumstances have changed justifying registration onto a different VAT scheme.
Accrual (standard) VAT versus cash accounting VAT
With standard accrual accounting, invoices issued within your company’s VAT quarter must be included within your VAT calculation. The amount of VAT you pay (or you are refunded on) depends on the total value of the output VAT on all invoices issued minus the total amount of input VAT on all invoices received.
For businesses operating on a longer client payment cycle (30 or 60 days after invoice issuance, for example), you will need to make sure that you have the cleared funds in the bank required to settle your VAT liability in full and on time.
All businesses with a turnover in excess of £1.35m per annum must operate the accrual system of VAT reporting and payment.
For companies with a turnover of £1.35m or less, their owners can choose to use the standard system or to use the cash accounting system instead.
With the cash accounting system, VAT is factored into your calculation based upon whether the invoices you have raised have been paid during the applicable VAT quarter.
For example, if your VAT quarter ends on the 28th of February and you issue an invoice on the 1st of January with 30-day terms which is not paid until 1st March, you do not have to include it in your VAT submission for 1st December to the 28th February. However, if your client pays you on the 28th February, the last day of that VAT quarter, then it must be included in the calculation for that quarter.
The cash accounting system is easier for cash flow management and it is relatively easy to calculate.
Let’s try a worked example to see how cash accounting might be more beneficial if you issue invoices with 30 or more days for your client to pay.
Let’s say that your business sells £20,000 a month worth of goods and services on which you charge VAT at 20%. Let’s also say that your average client takes around 60 days to settle their invoices.
At the end of a VAT quarter, you will have issued £60,000 worth of invoices generating £12,000 worth of output VAT. But because your customers are taking 60 days to pay you, you’re only actually banking £20,000 + VAT (£24,000) in cash although you have actually issued three times that cash amount in invoices.
On your first VAT bill after registering, you will pay VAT to the sum of £12,000 minus your input VAT if you are on accrual accounting. However, if you were on cash accounting VAT, your VAT liability would be the sum of £4,000 (the VAT on the invoices you’ve actually received money for) minus your input VAT.
For businesses new to VAT registration, more attention must be paid by directors to cashflow because, unlike prior to registration, there is now a sizable “cash event” every quarter for which you need to find the money. In nearly all cases, we would recommend that businesses registering for VAT whose turnover is less than £1.35m select cash accounting VAT if their customers take more than 30 days to pay them.
An Accounting Gem is here to help you to decide whether the VAT cash accounting scheme would be better for you rather than the standard accrual VAT scheme. Get in touch with us on 01473 744 700 or email us on email@example.com.