Cash vs accrual VAT scheme — which to pick
Which UK VAT scheme suits a small business, when to switch, and the cashflow trap most founders miss.
Cash basis: you pay VAT to HMRC when customers pay you. Accrual: you pay when you invoice. Most small UK businesses with slow-paying customers should be on cash basis. Eligible if turnover ≤ £1.35m. Switch costs almost nothing — but switching at the wrong time can create a one-off cashflow hit.
The two schemes
Standard (accrual) scheme is the HMRC default. You declare VAT on invoices in the quarter they were issued, regardless of whether the customer has paid. You owe HMRC the output VAT before any cash arrives.
Cash Accounting Scheme flips this. You declare VAT in the quarter the invoice was paid. You only owe HMRC after the customer has paid you. Mirror applies for input VAT on bills — you only reclaim once you've actually paid the supplier.
Cashflow worked example
Imagine you invoice £24,000 + £4,800 VAT = £28,800 in March, due in 60 days. The customer pays late in May. Your VAT quarter ends 31 March. You file by 7 May.
| Standard (accrual) | Cash | |
|---|---|---|
| Box 1 VAT due | £4,800 (invoice was issued in March) | £0 (customer hasn't paid yet) |
| You pay HMRC by 7 May | £4,800 — out of your pocket | £0 |
| Customer pays you 31 May | £28,800 arrives — you're fine retrospectively | £28,800 arrives, VAT due in next quarter |
For early-stage businesses with 30-60-day payment terms, cash basis prevents you funding HMRC's float with your own cash.
Eligibility
You can join the Cash Accounting Scheme if:
- Estimated taxable turnover for the next 12 months is £1.35m or less
- You're up to date with VAT returns and payments
- You haven't committed a VAT offence in the past year
You stay in the scheme until turnover exceeds £1.6m, at which point you must leave.
When to pick accrual instead
Cash isn't always right. Pick accrual if:
- You're cash-rich and pay suppliers fast. On accrual you reclaim input VAT immediately on the bill, even before paying. Cash basis delays the reclaim.
- You buy expensive capital items. A £20,000 piece of kit means a £4,000 VAT reclaim — better to claim it the day you order, not the day you pay.
- Your customers always pay on time (say, Stripe-collected B2C). Cash and accrual produce the same result, and accrual is the HMRC default with no paperwork to maintain.
- You're close to £1.35m turnover. You'll have to switch out anyway — might as well not switch in.
How to switch in
No application needed. You just start using cash basis from the first day of a VAT period. There's no form. Keep a record of when you switched in case HMRC asks.
How to switch out (the trap)
Here's where most people get hurt. When you leave cash accounting (voluntarily or because you crossed £1.6m), HMRC requires you to account for VAT on all outstanding invoices in your final cash-basis return. That can be a six-figure VAT bill all at once if you have a lot of unpaid receivables.
HMRC does offer six months to spread the payment — but most businesses don't know to ask. Plan the switch out months in advance.
Flat Rate Scheme — a third option
Worth mentioning briefly. For turnover up to £150k, you can join the Flat Rate Scheme: you charge VAT at 20% on sales but pay HMRC a fixed percentage of gross turnover (varies by sector — typically 12-16%). You don't reclaim input VAT on most purchases.
Flat rate used to be a tax break for service businesses. Since the "limited cost trader" rules in 2017, it's mostly only worth it for genuinely product-heavy businesses. Most consultancies, freelancers, and agencies are now better off on cash or accrual.
Bottom line
For most UK SMEs under £1m turnover with normal payment terms: cash basis. Switch out 3-6 months before you expect to hit £1.6m so you can plan the closing VAT hit.