Improve your cash flow part 1: Managing VAT

Effective cash flow management is one of the most important factors for both the profitability and sustainability of many small businesses.

VAT can provide a helpful contribution to cash flow, reducing the need for external sources of working capital such as costly bank overdrafts and loans, which will actually reduce your cash flow and profitability.

The shortage of credit has made cash flow management a focus for many small businesses. As all businesses are looking to improve their cash flow, VAT should be on your radar. If cash flow management hasn’t been on your mind, then you need to sit up and pay attention, as ‘cash is king’ for a reason.

Do not underestimate the importance of VAT in terms of cash flow in your business. Some estimates claim that VAT represents 15% of cash flow in the EU, which is much higher than any other business tax. In 2007, the UK government increased the turnover threshold for accounting for VAT on cash rather than an accruals basis to £1.35 million. Most businesses, other than retailers, can benefit from using the cash VAT scheme.

Now we’re in the middle of 2013, with a challenging outlook for the future, it is important to review how your working capital can be lowered and cash flow improved by using some of the mechanisms of VAT.

Here we’re going to concentrate on optimisation possibilities open to small businesses in a broad sense – focusing on ideas that are easy to implement without major changes to your business. These ideas should provide recurring cash flow gains which your business can obtain regardless whether it is profit or loss making.

How to maximise your VAT cash flow

VAT is mostly accounted for based on an accrual method, as opposed to a cash-based system. In practice, VAT is accounted for when the purchase and sales invoices are entered into your bookkeeping. It is possible to improve cash flow by advancing the timing of VAT deduction and/or recovery of purchase invoices.

Here’s an example: A £5,000 purchase invoice due to be invoiced on 1st October, could be invoiced on 31st September enabling you to offset the £1,000 VAT in the quarter to 31st September rather than the quarter to 31st December. Delaying issuing your own supply invoices by one day has the same effect. Together, this would provide you with interest free working capital of £2,000 for three months without any additional costs.

Therefore by asking your suppliers to invoice you just one day earlier, you can improve your VAT cash flow by three months.

Other VAT schemes

If your turnover is under £1.35 million, the annual VAT accounting scheme can be helpful. VAT is paid for the first three quarters on account on the normal due date. Any balancing amount for the last quarter is paid one month later than usual.

For example, with a quarterly VAT payment of £5,000 you have the use of £5,000 for an additional month. Also worth noting is that the VAT due on account is a quarter of your previous year’s VAT. If your business has increasing turnover, this could offer you a useful cash flow advantage.

If you have a slow paying customer you can reclaim the VAT when the debt is six months old, even if you might get paid after this. If you do get paid, simply include in your next VAT return. If most of your customers are regularly slow at paying and your turnover is under £1.35 million, the cash VAT accounting scheme may improve your cash flow.

Understanding your business’s trading patterns is also important to maximising your VAT cash flow. Have a read about other schemes available and more information on the Cash VAT scheme that may be beneficial to your cash flow.