Today’s blog post has been contributed by the wonderful Cheryl Sharp from Pink Pig Financials. Cheryl and I first met at a Masterminding Day in London, earlier in 2023. As a highly successful Businesswoman and Accountant, I reached out to Cheryl and was thrilled when she agreed to put together an article explaining VAT for small businesses…
Introduction to VAT
VAT feels a scary thing, but it’s a really good sign of a healthy growing business. So if you’re reaching the threshold, and therefore need to register for VAT, see it as a milestone to be embraced and celebrated, rather than something to fear and try to avoid.
First things first. Contrary to good old ‘Dave down the pub’ it’s not going to kill your business. For too long this myth has been going around and I’m here to (hopefully) take away some of that fear and mystery around VAT.
When to register for VAT as a Small Business
So first off – let’s talk about when you need to register for VAT. There are two options:
- Mandatory registration – where you reach the turnover threshold (read on for more)
- Voluntary registration – where you actually register before you need to – for a few different reasons
Let’s look at mandatory first – as this is probably the most common time you will register. So when your turnover (your sales) reaches £85,000 in any rolling 12 month period, you need to register for VAT within 30 days of going over the £85k point.
Now the rolling threshold here is really key – and something many people are not aware of. It’s not the 12 months of the tax year or the 12 months of your financial year if you’re a limited company – it literally is a 12 month period. So as you grow, and start invoicing around £7k per month you need to keep an eye on your sales. Each month literally add up the last 12 months sales and see how much they are. Then next month do the same and so on until you’re either at or very close to that magic £85k mark. This is when you need to start the process.
Now hopefully your accountant will be keeping an eye on this, but please keep an eye on it yourself too, especially if you’re not working with an accountant.
You then also have the option to register voluntarily. Now before you start ask ‘why on earth would you do something that doesn’t have to be done’ let me share a few things with you on why you may want to do this.
First off, depending on your type of business, and your customer base – they may require you to be VAT registered so they can work with you – so of course this is a huge reason to get registered! Similarly, depending on your industry, you may need to be registered to meet requirements, or ‘seem professional’ – which sucks, but you need to face these realities if that’s your industry. It can also help you to look bigger which could help you win contracts.
If your client base is all businesses that are also VAT registered – then it’s worth getting registered as they won’t care about you adding VAT and could actually mean better profit margins as you’ll be able to claim back VAT on your purchases – yay!!
And also, if you’re buying a lot of items to sell on with VAT – again, it could mean better profit margins.
And lastly – if your plan is to grow, especially grow quickly, then you may as well just get it done and dusted and will be one less thing to worry about as you grow!
Things to consider before becoming a VAT registered business
Something to consider when you are reaching the need to register is your pricing and what you’ll need to do once you are registered.
If you’re working with other businesses, then they’re likely to be VAT registered, so just add VAT to your prices, and they will just claim it back. Just let them know so they don’t get a surprise when the invoice lands in their inbox (you do email your invoices right? If not – this is something to sort asap!).
If you’re selling to the public or small businesses that aren’t VAT registered then you’ll need to think about this and plan it carefully. In an ideal world it would be a case of just adding VAT to your current pricing – but I appreciate the reality of that can be pretty daunting – I’m saying here to increase your prices by 20%!
Now I’m sure many of you probably aren’t charging enough for your true worth anyway, and probably should well be adding the full 20%, but if that’s just not possible then please don’t stress and think your business is over.
Remember you’ll now be able to claim VAT on your purchases – so your profit is now worked out on the purchase price less VAT – so say you were selling something for £10 and buying it for £6 your profit would have been £4.
But now that’s £5 plus £1 VAT that you’re buying it for, so if you add 10% to your prices to account for VAT, your sales price will be £9.16 plus VAT (£11 inc VAT), and that then gives you a profit of £4.16 (£9.16 – £5).
Now I know that’s pretty basic, but you can see where I’m going with it. So think about where you can increase your prices – some items/services you may be able to increase by a higher %, some a lower – but overall you shouldn’t loose out – and of course you’ll continue to grow, so if there is a small set back in profit you’ll soon grow and increase your profits!
Another thing to consider is VAT returns will need to be filed quarterly via some kind of accounting software – that’s the only way HMRC will accept them. So at PPF we recommend software from day 1, but if you’re not already there, then please do explore your options and try to get onto software before you register, so there isn’t too much change all at once!
Before I finish up here – one last thing to consider is ensuring your invoices are up to scratch. Once you’re VAT registered you’ll need to quote your VAT number on your invoices, and also show the VAT breakdown if your sale amount including VAT is over £100. Software like Xero will have this handled for you – so please don’t stress.
How does VAT work for small businesses?
I know this is a lot, and your head is probably 🤯but I just want to finish off with the basics of how VAT works.
The standard rate is as mentioned above – 20%, but there are a few other rates:
- 5% rate also referred to as the reduced rate of VAT – most common examples being residential electric and gas charges.
- 0%/zero rated – most common examples being food, medicine, water, children’s clothes, books (physical not eBooks), newspapers and new build homes
- exempt – most common examples being insurance policies and stamps
- reverse charge – this is common in telecoms and IT industries, and has also recently been introduced in the Construction Industry
The most common way to account for VAT is the standard scheme, which works as follows:
- Sale Price £100 plus 20% VAT = £120
- Purchase Price £10 plus 20% VAT =£12
- On quarterly VAT return you pay the £20 sales VAT (output VAT), but also reclaim the £2 purchase VAT (input VAT), meaning you actually pay HMRC £18 (the difference)
- Your profit is then £100 (sales price before VAT) less £10 (Purchase price before VAT) = £90 profit which you will pay corporation tax on.
VAT returns will be based on the dates of your sales invoices and purchase receipts using this method. You can also choose to use the cash version of this scheme – which works on the dates paid rather than on the paperwork. This is the most common for small businesses as it means you don’t hand the cash over to HMRC until it’s in your bank!
Make sure you keep hold of all your receipts for your purchases (as technically you can’t claim VAT on your purchases without them and you may need to show them if the tax man decides to inspect your returns) – even better – make sure your software has the capability to upload pictures/pdf copies of your receipts so they’re not taking up space in your office or loft!
VAT returns are usually filed each quarter – you can choose when you register, and we always recommend doing in line with your financial year end. At the end of each quarter you have one month and one week to get your return prepared, filed and paid! Or there will be penalties!
I’m going to finish up this section with a little warning – there are a few other schemes you can use to account for VAT – the main other one being flat rate. But please be careful here as the rules are not always very obvious. With flat rate you get a % rate for your industry, and use that to work out how much you need to pay HMRC each quarter. However in the small print there’s this thing called Low Cost Trader – and if you don’t meet certain criteria you have to use a higher % rate, which actually will end up costing you money as you’ll be paying HMRC more than you would if you used the standard or cash scheme. So please be careful and don’t get excited by the low rates on offer!
Becoming a VAT registered business - next steps
I’ve tried to cover all the basics here, but there is so much to VAT so please don’t be afraid to ask for help. I certainly couldn’t do all the things you do in your business, so you’re not expected to be across all the accounting things too – that’s what us accountants are for!
We have plenty of information around VAT (and dig into some of the above sections a bit more too!) on our website. And we’re here to help – you didn’t set your business up to stress about VAT returns – you did it to do the things you love and are good at! But I did! So if you need a helping hand please do reach out and we can set up a call to discuss how we can help.
If you’ve got to the end of this – go treat yourself to your favourite snack (or drink – wine maybe good after getting through this!) – you deserve it! 🙂 Thanks for reading!
CEO & Founder of Pink Pig Financials Ltd
Disclaimer: The £85,000 turnover threshold is correct at time of publishing for the 23/24 tax year.