The deposit we spent before we'd done the work

Taking deposits is good practice. It filters out time-wasters, it funds the materials, and it means you are not carrying the whole cost of a job on trust. Almost every well-run trades business, kitchen fitter, event caterer and bespoke maker takes them, and they should.

The trouble starts one layer down, in what happens to the money once it lands. Because a deposit arrives in the same bank account as everything else, looks identical to a sale on the statement, and gets spent like one. And a deposit is not a sale. It is a promise you have taken payment for and not yet kept.

A deposit is an obligation, not income

In accounting terms the money is a liability until the work is done — deferred income, or a payment on account, sitting on the balance sheet rather than in the profit and loss. The reason is not bookkeeping pedantry. It is that until you deliver, you owe either the work or the money back, and the costs of delivering that work have not been incurred yet.

Every profitable-looking business that has run out of cash has some version of this at its centre: money in the bank that has a job to do, being counted as money that is free.

The cash illusion, with numbers

Illustrative figures, but recognisable to anyone who takes 50% up front.

A fitting business has a good January. £42,000 of deposits come in across eleven new orders. £26,000 goes out in materials, subcontractors and wages on the jobs actually being worked on. The bank balance rises by £16,000 and everybody feels the business had a very good month.

Now look at what was really earned. Four jobs were completed in January, worth £22,000 of revenue, with £15,400 of materials and labour against them. That is £6,600 of profit. The other £16,000 of the cash swing is deposits on jobs not yet done — money with roughly £30,000 of future costs attached to it.

The business made £6,600 and banked £16,000, and nothing about the bank statement says which figure is which. February looks the same. So does March. Then the order book flattens — a quiet month, a lost tender, a seasonal dip — and the deposits stop arriving early while the costs of everything already sold land exactly on schedule. The cash does not gently level off. It reverses.

Growth funded by deposits is the same trick as growth funded by an overdraft, except nobody arranged it, nobody can withdraw it, and there is no facility letter to read. When the order book flattens, it withdraws itself.

That resemblance is not accidental. It is the same failure to distinguish timing from performance that produces the overdraft that quietly becomes permanent, and the same gap between the bank balance and the truth that sits behind cash flow versus profit.

Three rules that fix it

Separate the money, or at least separate the line. The cleanest version is a second bank account that deposits go into and come out of only as work is done. Where that is impractical, the minimum is a single figure you can produce on demand: total deposits held against work not yet delivered. If you cannot produce that number in under a minute, you do not currently know what your bank balance means.

Recognise revenue when the work is done, not when the cash arrives. Most bookkeeping packages handle this with a deferred income account and it takes a few minutes a month. The payoff is that your monthly profit figure starts telling you something true, which in turn means you find out about a bad month while you can still do something about it rather than at the year end.

Size the deposit to the committed cost, not to a round percentage. If a job needs £3,100 of materials ordered before anyone turns up, the deposit exists to cover £3,100, and 50% of a £12,000 contract is not a more accurate answer just because it is easier to say. Sizing deposits to cost also makes them far easier to justify to a customer, because you can explain exactly what the money is for.

The VAT point that catches people out

Here is the one that surprises owners. For VAT, receiving a deposit that forms part payment for a supply creates a tax point on the date you receive it, or the date you invoice for it, whichever comes first. The VAT is due on your return for that period — before the job is finished, and frequently before you have paid your own supplier for the materials.

So on that £42,000 of January deposits, if the work is standard-rated and the figures are VAT-inclusive, roughly £7,000 of it is VAT belonging to HMRC for the quarter in which the deposits landed. Not the quarter the kitchens get fitted. That is a very large slice of an apparently excellent month, and it is the single most common reason a business that has never had a VAT problem suddenly has one after a strong run of orders.

A genuinely refundable security deposit — the kind taken purely as security and returned in full — is treated differently. But most deposits in small business are part payment for the job, and part payment creates the tax point. If you are unsure which yours is, the question is whether the money is ever intended to be set against the price.

What happens when it goes wrong

Two consequences are worth holding in mind before the temptation to spend gets strong.

If a customer cancels, you can generally keep the losses you have genuinely incurred — materials ordered, time booked out, a subcontractor already committed. What you cannot safely do with a consumer is enforce a blanket non-refundable term that keeps the whole deposit regardless of what it actually cost you. A term that requires a consumer to forfeit a disproportionate sum can be challenged as unfair, and the practical test is whether the amount reflects real loss rather than punishment. Set deposits at a level you could justify with an invoice, and the problem never arises. The same instincts apply to what you must refund and what you can refuse.

And if the business fails, customers holding undelivered orders are unsecured creditors. They will usually get very little, and they will have paid in good faith for something they never received. That is a real harm done to real people, and it is the strongest argument for never letting deposits fund general trading. A business that could not deliver its order book tomorrow if all new sales stopped is carrying a risk its customers do not know they have taken.

The one-line test

At the end of every month, write down two numbers: the bank balance, and the total of deposits held against work not yet delivered. Subtract the second from the first.

That difference is the money you actually have. If it is negative, you are funding the business with customer money and one quiet month is all it takes for that to become everybody's problem. If it is comfortably positive, deposits are doing exactly what they should — de-risking the job rather than paying the wages. Either way, it takes about ninety seconds a month and it is the single most useful number a deposit-taking business can put on a whiteboard.

Common questions

Do I have to pay VAT on a deposit before I have done the work?

If the deposit is part payment for the supply, yes. Receiving the money creates a tax point on the date of receipt, or on the date you issue a VAT invoice for it if that comes first, and the VAT falls due on the return covering that period regardless of when the job completes. That can mean paying VAT on a kitchen in the quarter the order was placed and fitting it two quarters later. A genuine refundable security deposit taken purely as security is treated differently, but most small business deposits are part payment. Build the VAT into how you size and hold deposits rather than discovering it at the quarter end.

Should deposits go into a separate bank account?

It is the cleanest way to do it and it costs nothing but a little admin. A second business current account that deposits land in, and that money only leaves as work is delivered or materials are bought for that specific job, makes the distinction physical rather than theoretical. Where that is genuinely impractical, the workable substitute is a deferred income figure in your bookkeeping that you can quote at any moment. What does not work is intending to keep the money separate mentally, because the bank statement shows one balance and the temptation is constant. Physical separation removes a decision you would otherwise have to make weekly.

Can I keep the deposit if a customer cancels?

You can generally retain the losses you have actually incurred — materials ordered specifically, subcontractor time committed, work already carried out. What is risky with a consumer is a blanket term saying the deposit is non-refundable in all circumstances, because a requirement to forfeit a disproportionate sum can be challenged as an unfair term. The safe approach is to set deposits at a level that reflects real committed cost, state clearly in writing what happens on cancellation, and be able to evidence the loss with invoices if it is ever questioned. Business-to-business contracts have more freedom, but the same evidence still helps.

How large should a deposit be?

Work from the committed cost rather than a percentage. Add up what you have to spend before the customer sees any progress — materials, specialist hire, a subcontractor's mobilisation, any bespoke item you cannot resell — and set the deposit to cover that with a small margin. On a job with heavy material costs that might be 40% or more; on a labour-only job it might be 10%. Round percentages feel fairer but they systematically over-collect on some jobs and leave you exposed on others. Costing the deposit also gives you a straightforward explanation for the customer, which is usually the end of any negotiation about it.