How To Account For Customer Advance Payments

Your customers can make advance payments on whatever purchases they wish to complete. An advance payment entails someone paying for something before delivering that product or service. It works mainly for expensive products or custom-made items, although it could also work when someone has poor credit and needs to cover part of a cost. 

You could get an advance payment before you have done anything to fulfill the customer’s wishes and earn that payment. You can account for customer advance payments with a simple practice to ensure you’re getting the funds you need. You can use the right plans to ensure you’ll get your payments running the right way without risking any possible losses or incorrect pieces of data.

Why Do Customers Pay In Advance?

Advance payments come in many forms. These payments include instances where someone pays for a year’s access to something charged by the month. A person could also make a down payment on something more expensive.

There are many reasons why customers might pay for things in advance:

  • They might have poor credit and will have to pay for something in advance. Those who have good credit would be more likely to pay for something when they get it.
  • A customer might be ordering something unique. It could be a customized product that requires advance payment before the seller can start producing the product.
  • A seller might be planning a reserved capacity structure where a customer pays for something to reserve production. The funds are transferred to ensure the buyer will use the seller’s services and won’t transfer over to a competitor for something.

Liability Reporting

The best way to report an advance payment is to list it as a liability. A liability is something that a company is responsible for managing. The company is responsible for providing the product or service that the customer is paying for before using this feature.

The asset will be a liability until the seller fulfills an obligation. Here’s a look at how this works:

  1. You will complete the initial recording of the payment when the account pays you the advance payment. All advance payments should appear in a liability invoice.
  2. You will remove the funds from the advance payment from your cash account. The funds will then go to your advance account where you reserve the money for covering the needs your customers have.
  3. After the liability is fulfilled, your business can remove that liability from your liability invoice. You can use the remaining income you earned after completing the liability to manage other things in your workplace.

The effort ensures you recognize the needs your customer has while serving the person. It also organizes your funds surrounding what you’re managing in the process.

Here’s an example to help you understand the process. Let’s say someone pays you $2,000 to order a custom bicycle. You will record that $2,000 payment with a debit to your cash account while recording that same total as a credit to your advance account. After producing and delivering that bicycle, you will debit the $2,000 from your advance account. The $2,000 will then go to your cash account. 

After this, you will no longer be liable for the advance purchase because you have already covered the effort and delivered what the customer wanted.

Unearned vs. Earned Income

You can also include a listing of your income in your report surrounding what you are earning versus what you’re not getting. Earned income entails income you can post in your income statement when you send an invoice. Unearned income is what you will report as a liability because you haven’t followed anything of value.

Timeframe For Managing the Liability

Any liability that you will earn within a year should also appear as a current liability. It means that you will resolve that liability very soon. Anything you don’t plan on covering within that year will be a long-term liability.

What Makes This Essential?

Your accounting effort will ensure you can keep the cost for delivering products and services under control. You’ll reserve your advance payments for all those liabilities you incur.

The effort keeps your profit margin under control. You won’t be as likely to dip into your regular reserves to cover your liabilities if you keep these things under control.

Incorrect accounting can harm your business, as you might report your advance payments as income. You could assume your revenues are higher and more valuable than they are, making it harder for you to handle your funds and organize your work.

Manage Your Collections Right

The last part of recording your advance payments is to ensure you record the right values as you collect. You might not always get the entire total right away. You might collect much of the payment now and then the rest after you finish fulfilling the customer’s order.

You can request a proper advance payment making up a percentage of the total value of the order if necessary. You can base the value on the size of the order, the cost percentage surrounding the materials for the purchase, and the total cost of staffing people who will facilitate the order. You can record the purchase you collected as a liability and then add the future payment to a separate segment that fits your needs.

Be Cautious With Your Work

People will be interested in paying for things in advance for many reasons. Some may prefer the idea, while others might have to due to poor credit issues. You can benefit from accepting advance payments, but whatever you collect should be reasonable and easy to manage.

Look at how you’re running your advance payments and that you record them right. Be sure you accurately report these payments and that you won’t struggle in reporting these features. You will have an easier time managing your work and your finances when you report these well.

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