How much to set aside for tax and VAT each month

Jan 20

Want to avoid one of the most common cash flow issues this year?

One of the most common (and painful) financial mistakes small business owners make is not putting money aside for tax or VAT. It’s easy to do, you get paid, you reinvest, you spend…and then the tax bill lands, and suddenly there’s a cash flow crisis.

But, this is totally avoidable with a simple habit and a bit of planning.

If this is you or you’re coming close to the VAT threshold keep reading.

The common problem

When money hits your business account, it’s tempting to see it as yours. But the reality is, a good chunk of that money isn’t really yours at all, it belongs to HMRC. Shit I know but it’s reality.

If you don’t set it aside, you’re effectively “borrowing” from your future self. And the problem is, your future self will have to find that money later, often at the worst possible time.

The solution…pay yourself second

The simplest way to fix this? Treat tax and VAT like any other bill you can’t ignore.
Every time you get paid, set that money aside immediately, before you pay yourself, buy stock, or do anything else.

Think of it as paying HMRC first, yourself second. It takes discipline at first, but you’ll thank yourself when the bill arrives and you’ve already got the cash waiting.

So, how much should you set aside?

Here’s a rough guide to what you should be putting away from your gross revenue (the total amount you invoice or receive before costs):

If you're VAT registered (standard rate, 20%)

Set aside 35 to 40% of every payment you receive.
This roughly breaks down as:

20% VAT (on sales, minus any VAT you can reclaim)
15 to 20% for income tax and National Insurance, depending on your profit level

If you're not VAT registered

Set aside 20 to 25% of every payment.
That’ll usually cover your income tax and National Insurance.

If you run a limited company

Set aside 30 to 45% of every payment you receive.
That accounts for:

20% VAT (if you’re registered)
19-25% Corporation Tax (on profits)
Plus a bit extra for personal tax if you take dividends

Disclaimer - These figures are rough - it all depends how much profit you make/are predicted to make. Also what VAT you pay.

Your weekly/monthly savings plan

Here’s a simple step by step way to make this automatic.

Step 1. Open a separate savings account

Open a dedicated “Tax and VAT” savings account, separate from your business current account.

Lots of business owners use an instant access savings account so the money can still earn interest while it’s sitting there.

Alternatively use a business account which allows you to use ‘pots’ where you can send/save money aside from your main account.

Step 2. Automate when possible

Set up a standing order or make it a rule to transfer your set percentage.

Weekly earners. Move it every Friday or at the end of each week
Monthly earners. Transfer it the same day each month (e.g. the 1st or the day after payday)
Per-invoice earners. Transfer it within 24 hours of being paid

I would advise weekly for most people reading this.

Step 3. Calculate your exact amount

Example 1. You receive £5,000 this month and you’re VAT registered
→ £5,000 × 35% = £1,750
Transfer £1,750 straight into your tax account.

Example 2. You invoice £500 this week and you’re not VAT registered
→ £500 × 25% = £125
Transfer £125 into your tax account.

A few special considerations

If your expenses are high
If you have big costs (say, 50% or more of your revenue), you might be able to lower your tax saving percentage slightly since you’re only taxed on profit, not total income. But remember, VAT is still calculated on your full sales (minus VAT on expenses).
When in doubt, it’s always safer to over save than under save - I personally always air on the side of caution and when there’s some ‘left over’ it’s a little bonus.

Review it annually
Check your percentages with your accountant once a year. They might need adjusting if your margins change, if you switch to the Flat Rate VAT Scheme, or if tax thresholds shift.

Basically…

Every time money comes in, move your percentage out straight away. No exceptions, no “I’ll do it later.”

That 35 to 40% was never really yours anyway, it just passed through your account on its way to HMRC. By treating it like it’s already gone, you’ll never be caught short when the bill arrives.