It's a holidaymakers' worst nightmare. The suitcases are packed and you're raring to go when a letter comes through from the travel company saying they've had to cancel your trip. Or, worse still, you realise you've booked to go away on the same day as your sister's wedding and have to cancel it yourself.

Both scenarios mean the daydreams you've had since booking have turned into a nightmare - you won't get to laze on that beach, trek through those mountains or negotiate that first black run. And one of them could leave you counting the financial as well as the emotional cost.

You cancel your holiday

Nobody likes cancelling a holiday, but sometimes you don't have a choice. Chin Maguire, 26, missed out on the holiday of a lifetime when a complication during pregnancy forced her to pull out of a round the world trip.

"I'd been massively looking forward to it and was really gutted when we had to cancel," she says. "Luckily, the travel company were really sympathetic and gave us most of our money back."

Not everyone is so lucky. The moment you book a holiday you are entering into a contract with the organisation providing the service. If you break that contract you are liable to lose your deposit or pay a cancellation charge, which can be the full cost of the holiday. If the contract doesn't allow cancellation, you will be liable to cover any losses the travel company might have.

In this instance your only source of protection is travel insurance. Check the small print of your policy to see if you're covered in the event of you cancelling the trip but beware of trying to be clever by putting a stop on any cheques to the travel company, as they may take you to court for compensation.

"Good travel insurance will cover the cost of cancellations made for good reason," says Derek Moore, chairman of the Association of Independent Tour Operators [AITO]. "They won't refund for disinclination to travel. If you suddenly decide you don't want to go somewhere, that's not enough reason for them to give you your money back."

You cancel a package

You can cancel a package holiday if the tour operator changes something significant like a departure date or hotel choice before you go. You may also be able to transfer the trip if you can't go for reasons beyond your control, like the death of a close relative.

If you cancel for any other reason you will be liable to pay a cancellation fee, which will be advertised in the brochure if your tour operator is a member of the Association of British Travel Agents [ABTA].

The tour operator cancels

Tour operators are as loathe to cancel holidays as holiday makers are. It can be costly in terms of money and reputation, but sometimes they have to pull flights, hotels and packages because there are not enough people booked to make them financially viable or because of circumstances beyond their control. Think ash clouds, tribal violence and swine flu.

If the tour operator does cancel the gig then the balance of power swings firmly in your direction. They should offer you your money back and, if it is a package holiday, they will offer you the choice of an alternative or superior package, an inferior holiday plus a refund on the difference in cost or a complete refund.

"I was booked to go to Barcelona with my boyfriend," says Naomi Benoist, 24. "It was our first holiday together and I was really looking forward to it, then the ash cloud appeared and lots of flights got grounded. It was touch and go but on the morning of the trip, the tour operator told us they were going to have to cancel it. I was really disappointed not to be going but the company were great and gave us our money back with no hassle at all."

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Updated: 17/10/2011

Written by Paul French