Maximising revenue is the key to mastering your cash flow. The more money you have going into your business, the easier it is to allocate funds for capital investments, pay your bills on time and retain positive relationships with your suppliers. The trouble is that it can often seem as though funds are leaving your business faster than you can claw them back.
In some instances, it may make more sense to implement advance payments for new clients, or those that have a history of late payment. However, advance payments need to be accounted for in order to balance your books and keep your business finances harmonious.
Here, we’ll look at how to properly account for advance payments.
What are advance payments?
Advance payments is an umbrella term for any revenue that is received in advance of goods or services being delivered and payment being earned by the company. Advance payment is often used as a form of insurance to mitigate the risks associated with non-payment. Some companies exclusively take payment in advance, while others reserve it for special circumstances.
These might include:
When a customer has a poor credit history and it would be a liability to extend credit to them.
When capacity for a product is reserved or limited.
When a product is custom-made for a customer and could not be resold.
Customers that use the cash method of accounting, as opposed to the accrual method, will also rely on advance payment, so that they can write off their expenditure as soon as possible.
Examples of advanced payments
We often experience advance payments in day-to-day life, as well as in our business endeavours. Advance payments may include:
Paying for a magazine subscription / streaming service for the full year rather than paying by the month.
Paying monthly premiums to your insurance company in exchange for their protection later.
Making a down payment to an outsourced creative marketing or web design team for work to be carried out later.
Paying your solicitor a retainer.
How to account for advance payments
If your company receives revenue in advance, it’s important to ensure that it is properly accounted for. The accrual accounting method dictates that revenues received before they are earned (by the product being delivered or the service being rendered) are reported as a liability. When advance payments are earned within a year (as is usually the case), they need to be listed as current liabilities.
Whenever an advance payment is made, the accounting entry is expressed as a debit to the asset Cash for the amount received. A credit also needs to be made to the liability account – something along the lines of Advance Payments, Unearned Revenue, or Customer Advances.
After the full value of the advance payment has been earned, the liability account must then be debited for the amount earned, crediting the revenue account via an adjusting entry.
Why is accounting for advance payments important
Advance payments are great for boosting revenue and ensuring that the costs of delivering a product or service don’t impinge heavily on your profit margins. The more advance payments are received, the more distance you can keep between your top and bottom line. However, advance payments can, if not properly accounted for, become a rod for your back. They can give a misleading account of your company’s finances and cast a rose-tinted hue over them. This is why it’s essential to be proactive in accounting for them properly.
We can help
If you’re interested in finding out more about advance payments, the right way to account for them or any other aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.