You do need to see a financial advisor, because you have different options.
As it stands, you have £200-£250k equity in the flat, £200k inheritance and could borrow around £150k... So if you sell, you can look at houses £400-450k mortgage free, or up to £600k if you borrowed.
If you used the inheritance to pay off the mortgage on the flat and kept it, you could still use it as equity, by taking out a BTL. These are a max 75% and valuations for BTL tend to be low (as I know, cos I've just had one! 
), so you'd release about £250k capital and still have the flat to let out and generate a healthy income. You'd still be able to take out a residential mortgage of about £150k, and you'd have £60-70k of the inheritance left (after fees), so you could still buy a new house around £400-450k, but you'd have two mortgages - BTL and 'normal' resi.
I'm doing the latter atm (tho' all my figures are much smaller!). I have been mortgage free for the past 8 years, but am doing BTL on my current house because the market is slow to release equity and buy a bigger house with garden.
I'm apprehensive to say the least! It has been really liberating to be mortgage free - to know I can't lose my home, that I can always keep a roof over my children's heads, and to have lots of disposable income and not have to count pennies. So TBH, I'd say this is a psychological decision as much as a financial one - are the space/garden more important than total financial security? In the end, I have decided that for me, they are...
Good luck, whatever you decide! :)