Q. I have recently registered for VAT. What is the difference between 'normal' and 'cash' accounting?
A. Under the normal method of accounting for VAT, you account for the output tax on your sales as they take place or as soon as you issue a VAT invoice, even if your customer hasn't paid you. Then you can reclaim input tax on purchases you make as soon as you receive a VAT invoice, even if you haven't paid your supplier. This method can cause cash flow problems if you have to pay a VAT bill before your customer pays you.
The cash accounting scheme, which is available to most businesses with an annual taxable turnover up to £1.35m, turns this normal method upside down. In cash accounting, you account for the output tax when you receive payment for the sale, rather than when the customer received the goods or service. So this way, you have the money from your customer to pay the VAT you charged on his bill. However, this scheme cuts both ways because you can only reclaim the input tax once you pay your supplier, which means that when your VAT bill is due you can't offset the VAT you owe suppliers against your total bill.
The cash accounting scheme can help your cash flow because in general you don't have to pay VAT until your customers have paid you. The scheme is especially helpful if you give your customers extended credit or suffer a lot of bad debts. However, the scheme may not give you any benefit if you:
- are usually paid as soon as you make a sale;
- regularly reclaim more VAT than you pay; or
- make continuous supplies of services.
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