Cash flow is king for any small business. Can a good tax accountant actually help improve your cash flow? Here is a real example from a client story. A sole trader recently bought a van on hire purchase. They were VAT registered and, like many small businesses, used cash accounting for both VAT and income tax.
Cash accounting works well in most cases. You only pay VAT when customers pay you, and reclaim VAT when you pay suppliers. For income tax, you are taxed only on what you actually receive, so there is no risk of paying tax on bad debts and putting pressure on cash flow.
It is simple, practical, and cash flow friendly.
So naturally, they assumed they could reclaim the VAT on each hire purchase instalment as they paid it. It sounded logical. But this is where it gets interesting. Hire purchase is one of those exceptions that catches people out. Even if you are on VAT cash accounting, hire purchase is excluded from the scheme, which means normal VAT rules apply instead. In effect, the VAT is treated as if the full amount has been paid upfront. So the full VAT can be reclaimed based on the invoice value and it is not linked to instalments.
In this case, once we reviewed it properly, the full VAT on the van was reclaimed straight away, even though only the deposit had been paid. That makes a real difference to cash flow. You are not waiting months or years to recover VAT on a major purchase.
There is another angle to this as well. We had another client who was under some cash flow pressure, and their suppliers were offering extended credit terms. What many people do not realise is that if an invoice is payable after more than six months, that transaction is also excluded from VAT cash accounting and standard scheme applies.
We worked with the suppliers to extend the payment terms beyond six months. As a result, the client was able to reclaim VAT upfront even though the payments were deferred. In simple terms, nearly 20% of their supplier liability got back into the cash flow which was a significant boost when cash flow is tight. One thing to keep in mind is that the income tax treatment does not follow the VAT position. The monthly payments are not fully deductible. Only the interest element is an allowable expense, and that is deducted when it is paid. The cost of the van is then claimed through capital allowances over time.
So the same transaction is treated differently depending on whether you are looking at VAT or income tax. This is often where mistakes happen, either by delaying VAT claims unnecessarily or by treating the full instalments as expenses.