How hitting the VAT threshold hits a business
Let’s talk about VAT because whether you’re paying it or not, it’s something most business owners I speak to either a) don’t fully understand or b) don’t account for in their figures.
And both of those can lead to a huge cash flow problem.
If you run a small business in the UK, there’s one number you need to keep a close eye on, £90,000. That remains the VAT threshold as of April 2024, and if your taxable turnover creeps over it within any 12 month rolling period, you’ll have to register for VAT. And that’s when things start to change.
For many small business owners, hitting the VAT threshold can feel like an invisible wall, one that suddenly makes everything more complicated and eats into profits. But while it does bring extra costs and admin, it doesn’t have to be a business killer. As always being aware and planning for these things are what will save you.
I’m going to tell you exactly what happens when you hit the VAT threshold, how to prepare for it, and how to push through without your cash flow taking a beating.
What happens when you hit the VAT threshold?
Once your turnover exceeds £90,000 in any rolling 12 month period, you have 30 days to register for VAT with HMRC. From that point, you’ll need to:
Charge VAT on your sales (for most people reading this it’ll be at 20%)
Submit VAT returns (quarterly)
Keep VAT records and maintain a VAT account
Pay VAT to HMRC, after deducting any VAT you’ve paid on business expenses (if you’re in the standard VAT scheme of 20% that is).
Sounds simple enough, right? But the reality can be quite different.
The immediate impact on your business
One of the biggest questions when you hit the VAT threshold is whether you should be passing the VAT on to the customer or absorbing it. Often your hands are tied on this in reality, it’s very difficult in an ecommerce business to just whack on 20%.
Tip - if you’re reading this pre VAT registration make sure you try and account for this in your prices before you’re really hit with it.
For businesses selling to VAT registered companies, it’s not such a big deal, your customers can reclaim the VAT you charge (i.e. wholesale). But if you sell directly to consumers or small businesses that aren’t VAT registered, your prices effectively go up by 20% overnight or your profit goes down.
Let’s say you’ve been selling a product for £50. If you keep your prices the same, you now have to give £8.33 of that to HMRC, leaving you with just £41.67. If you increase your price to £60 to account for VAT, you risk outpricing yourself.
This is where many small businesses struggle. Margins shrink, competitiveness takes a hit, and cash flow suddenly becomes an issue.
The VAT registration process
If you cross the threshold, registering for VAT isn’t optional, it’s a legal requirement. So, when this happens, what do you need to do?
Check your rolling 12 month turnover. The threshold isn’t based on a tax year or calendar year, it’s any consecutive 12 month period.
Register with HMRC. You can do this online via the HMRC website.
Receive your VAT number. HMRC will send you a VAT registration certificate, usually within 30 working days.
Start charging VAT. From your registration date, you must add VAT to your prices and issue VAT invoices.For most businesses that means absorbing the VAT and ticking the right box in Shopify to split the VAT proportion of your selling price to the customer at checkout.
Submit VAT returns and payments. VAT is usually reported quarterly.
You may also have the option of joining VAT schemes like the Flat Rate Scheme, which simplifies VAT calculations for some businesses. Google this to see if you’re eligible, I won’t cover it here.
How to push through the VAT threshold
You have to plan for it and price it into your strategy. Here’s how:
1. Adjust your pricing strategically
You have two choices:
Absorb the VAT cost and take a hit on your margins.
Increase your prices and potentially lose some customers (but not always).
Many businesses find a middle ground, gradually increasing prices over time to soften the impact. You can also look at ways to add more value to your products to justify the higher price.
2. Put VAT aside monthly - this is IMPORTANT!
VAT isn’t your money, it’s HMRC’s. Instead of treating it as income, put it aside. A good approach is to:
Open a separate bank account or pot (in the likes of accounts like Starling) just for VAT.
Transfer 20% of your sales revenue into it regularly - this will cover your VAT bill with a slight buffer too if you’re claiming some VAT back.
This way, when the VAT bill comes, you’re not scrambling for cash.
3. Monitor your cash flow closely
VAT can create short term cash flow problems, especially in businesses with tight margins. The key is to forecast ahead and make sure you have enough of a float.
Use software like Xero or QuickBooks to track VAT liability.
Consider short term financing options if needed to smooth cash flow dips, but do NOT rely on this.
Negotiate better payment terms with suppliers to keep money in your business for longer if possible.
4. Plan for growth beyond VAT
Some businesses try to stay under the VAT threshold by limiting sales, but this can stunt growth and I would never recommend it if you’re focused on growth. Instead, focus on pushing past it by scaling your business.
Also remember…VAT is a sign of success.
Hitting the VAT threshold means your business is growing, it’s not a bad thing! But it does require planning, particularly if your customers are price sensitive. The key is to be proactive.
Track your turnover carefully so you’re not caught off guard.
Adjust pricing and margins in advance.
Put VAT aside as you go to avoid cash flow shocks.
Plan for long term growth, rather than limiting your success to stay under the threshold.
The key is to power through it so if you’re reading this and you’re nearly there or you’re paying VAT and feeling the pinch, now is the time to really pull your finger out and get your business moving quicker.