How Does Invoice Finance Work With VAT?
The provider advances a percentage of the gross invoice value including VAT. When you receive the advance, the VAT element is included. This means you have the VAT cash available to pay HMRC on time instead of waiting for the customer to pay. On a £12,000 invoice (£10,000 + £2,000 VAT) with 85% advance, you receive £10,200.
Why This Matters
For UK businesses using invoice finance, understanding how VAT is handled is critical to cashflow planning and avoiding HMRC penalties. When you issue a VAT invoice, you owe that VAT to HMRC on your next return, typically within 30 days, regardless of whether your customer has paid. Without invoice finance, a business invoicing on 60-day terms faces a painful cashflow gap: VAT is due to HMRC before the customer pays. Invoice finance solves this by advancing against the gross invoice value (including VAT), so you receive the VAT element upfront. On a £60,000 gross invoice (£50,000 plus £10,000 VAT) with an 85% advance, you receive £51,000 immediately. This £51,000 includes £8,500 of the VAT due, giving you the cash to pay HMRC on time. The alternative, waiting 60 days for customer payment, forces you to fund the £10,000 VAT gap from working capital or an overdraft. For fast-growing businesses or those with stretched cashflow, this VAT timing mismatch is a common cause of distress. Invoice finance eliminates it, turning a liability into managed cashflow.
Key Points
- The advance percentage applies to the gross invoice total (net amount plus VAT), not just the net sale value.
- On a £12,000 invoice (£10,000 net plus £2,000 VAT) with 85% advance, you receive £10,200 immediately, which includes £1,700 of the VAT element.
- This advance gives you the cash to pay HMRC on your VAT return deadline, typically before your customer pays the invoice.
- The remaining 15% (£1,800 in this example, including £300 VAT) is held as a reserve and paid to you when the customer settles, minus finance charges.
- Invoice finance charges (typically 1.5% to 3.5% per month on the advance) apply to the full advance including VAT, so you pay a small interest cost on the VAT portion.
- Providers like Close Brothers, Bibby Financial Services, and Aldermore all advance against gross invoice values as standard practice across factoring and invoice discounting.
- You still declare the full invoice value on your VAT return in the period you raise it, the finance arrangement does not change your VAT accounting obligations.
Real-World Example
A Birmingham IT consultancy invoices a retail client £24,000 (£20,000 net plus £4,000 VAT) on 45-day payment terms. Their factoring facility with Skipton Business Finance advances 80% within 24 hours.
The consultancy receives £19,200 immediately (80% of £24,000), which includes £3,200 of the £4,000 VAT due. When their quarterly VAT return falls due 30 days later, they have the cash to pay HMRC the full £4,000 without dipping into overdraft. When the client pays on day 45, Skipton releases the remaining £4,800 reserve minus fees of around £288 (1.5% monthly for 1.5 months on £19,200), netting the consultancy approximately £4,512.
Common Pitfalls
- Forgetting that finance charges apply to the VAT portion of the advance, marginally increasing the effective cost compared to the net invoice value alone.
- Assuming the advance percentage applies only to the net amount, leading to incorrect cashflow forecasts when budgeting for VAT payments.
- Failing to account for the VAT element in the reserve when calculating available working capital, particularly if multiple invoices are outstanding.
- Using flat rate VAT scheme assumptions with invoice finance, the advance is always against the gross invoice issued, not your simplified VAT liability.
What to Do Next
- Calculate your typical monthly VAT liability and compare it to your average invoice payment terms to quantify the cashflow gap invoice finance would close.
- Request illustration quotes from providers like Ultimate Finance or Novuna Business Finance showing advance amounts on sample invoices including VAT to see real figures.
- Review your VAT return deadlines and customer payment patterns to identify periods of maximum cashflow pressure where advancing VAT becomes most valuable.
Related Questions
Do I pay finance charges on the VAT portion of the advance?
Yes. Charges apply to the total advance amount including VAT. On a £10,200 advance (85% of £12,000 gross), you pay interest on the full £10,200, not just the £8,500 net portion. This adds marginally to the cost but the cashflow benefit of having VAT cash available typically outweighs the extra £30 to £50 per invoice in interest.
What happens to the VAT if my customer disputes the invoice?
You remain liable to HMRC for VAT on invoices raised, even if disputed. The finance provider holds the reserve until resolution. If you credit note the invoice, you reclaim the VAT on your next return and must repay the advance plus fees to the provider. Providers like Bibby and Close Brothers require you to manage disputes and VAT adjustments directly with HMRC.
Can I use invoice finance if I am on the flat rate VAT scheme?
Yes, but the mechanics differ slightly. You still invoice customers with standard VAT shown, and the provider advances against that gross amount. However, you pay HMRC a flat percentage of your gross turnover, not the VAT shown on invoices, so you may retain a margin. The advance still solves the timing gap between issuing invoices and receiving payment, regardless of your VAT scheme.
Director, Market Invoice
Oliver leads Market Invoice's editorial and comparison research. With a background in UK commercial finance, he oversees provider analysis, rate verification, and industry reporting across all verticals.
Last reviewed: 6 April 2026