VAT for Small Business / Lesson 4 of 8
Cash accounting and annual accounting
Paying HMRC VAT on an invoice your customer has not paid yet. There is a way out.
The short answer
- ✓ Cash accounting means VAT is due when you are paid, not when you invoice
- ✓ The same timing applies to reclaiming VAT on your purchases
- ✓ Bad debts are handled automatically under cash accounting
- ✓ Annual accounting means one return a year with instalments, unsuited to repayment positions
The problem cash accounting solves
Under standard VAT accounting you account for VAT when you invoice, not when you are paid. Invoice in March, get paid in June, and the VAT was due to HMRC long before the money arrived.
Invoice raised 20 March, paid 15 June
STANDARD VAT falls in the quarter ending March
You pay HMRC before the customer pays you
CASH VAT falls in the quarter ending June
You pay HMRC only after being paidFor a business with slow-paying customers this is the difference between comfortable and constantly short.
The trade-off
The same rule applies to your purchases. You reclaim input VAT only when you have actually paid your suppliers, not when they invoice you. A business that is paid quickly but pays its own suppliers slowly is usually better off on standard accounting.
Bad debts
Cash accounting handles bad debts automatically: if you are never paid, the VAT never becomes due. Under standard accounting you must pay the VAT and then reclaim it later through bad debt relief, which has its own conditions and waiting period.
Annual accounting
A different scheme addressing a different problem. You submit one VAT return a year instead of four, and pay by instalments through the year based on an estimate, with a balancing payment at the end.
| Suits | Does not suit |
|---|---|
| Businesses wanting predictable payments | Businesses usually in a repayment position |
| Stable, predictable turnover | Rapidly growing businesses |
| Anyone who finds quarterly admin a burden | Anyone wanting refunds quickly |
If you normally reclaim more than you charge, annual accounting means waiting a year for money you would otherwise receive quarterly. The two schemes can be combined where you qualify for both.
The bit HMRC does not spell out
You must leave cash accounting once your turnover exceeds the exit threshold, and that exit is not optional. A growing business can be pushed back onto standard accounting at exactly the moment its cash flow is tightest, and the transition means accounting for VAT on outstanding invoices that had not yet been paid.
Worth modelling before you grow into it rather than discovering it in the quarter it happens.
Common mistakes
- Joining cash accounting when you pay suppliers slowly. It delays your reclaims too.
- Using annual accounting while in a repayment position. You wait a year for refunds.
- Not planning for the exit threshold. Growth forces you off the scheme.
- Assuming schemes change what you owe. They change timing, not the total.
Try it on your own numbers
This is the same calculator as the full tool page, using 2026/27 rates.
Your VAT return
Work out the VAT you owe HMRC (or can reclaim) for the period.
UK standard rate is 20%. Reduced rate 5%, zero rate 0%.
Compare paying a single flat-rate percentage of your VAT-inclusive (gross) turnover instead of the standard method. You generally cannot reclaim input VAT on the Flat Rate Scheme.
Sector rates vary (e.g. 14.5% IT consultancy, 12% catering). Limited cost traders use 16.5%.
VAT due = output VAT − input VAT (Box 5 of your return). A negative figure means HMRC owes you a repayment.
- Box 1 - Output VAT on sales
- Box 4 - Input VAT reclaimed
- −
- Box 5 - Net VAT due
- Box 6 - Net sales (ex VAT)
- Box 7 - Net purchases (ex VAT)
Gross sales (inc VAT)
VAT kept from customers
Flat Rate vs standard method
Standard method
Estimate only. Always reconcile against your records before submitting via Making Tax Digital.
Projected VAT across the year
If every quarter looked like this one, here is how much VAT would build up over four returns.
Set aside roughly each quarter - about a week - so the bill never surprises you.
Compare saved periods
| Period | Output VAT | Input VAT | Net due (Box 5) | |
|---|---|---|---|---|
| Year to date (saved) |
Key takeaways
- ✓ Cash accounting means VAT is due when you are paid, not when you invoice
- ✓ The same timing applies to reclaiming VAT on your purchases
- ✓ Bad debts are handled automatically under cash accounting
- ✓ Annual accounting means one return a year with instalments, unsuited to repayment positions
Check you have got it
3 quick questions. No score is kept, and you can change your mind.
1. Under standard VAT accounting, when is VAT on a sale due?
2. You are paid quickly but pay your own suppliers on long terms. Is cash accounting good for you?
3. Who is annual accounting least suited to?
Sources
Finished this lesson?
Mark it done and we will remember where you got to.
You are 4 lessons in. Want to keep your progress?
Right now your place is saved in this browser only. A free account keeps it across devices, unlocks the end-of-course exam and certificate, and gives you a personal action plan at the end. No card, no upsell.
