What is an advance payment invoice?
As the name suggests, an advance payment invoice is a type of advance payment where you send an invoice to your customer and receive the cash before supplying any goods or providing the service. It is also known as an advance bill invoice. In this case, the customer will debit an upfront payment, inflating your accounts payable. The payment can be a deposit, a partial settlement of the invoice value, or the total amount payable before the due date.
Opting for payment requests in advance will depend on your company policy and personal preference. Irrespective of your reasons, your company must adhere to accounting standards when recording advance payment invoices. Read on to understand why advance payment invoices can be a game-changer for your company.
Why your company needs an advance payment invoice
Introducing advance billing as part of your payment processing is good business practice when sharing your quotation.
Considering customers pay 81% of invoices 30 days late, and small business’ accounts receivables ballooned to a staggering $825 billion, small business owners should welcome upfront payment financing options.
Embrace advance payment invoices because it:
- Maintains cash flow, ensuring your business stays afloat.
- Enables you to avoid bad debt such as bank loans, unpaid factored invoices, and uncovered expenses.
- Removes the burden of debt recovery and management. Making follow-up for bills in arrears is hectic and time-consuming.
- Enables you to cover costs and expenses incurred when handling projects or offering a service.
- Provides the start-up capital for the business transaction under the advance payment.
- Reduces the chances of falling out with customers.
- Eliminates uncertainties because the advance payment acts as a surety.
Unfortunately, when handling advance payment invoices, you may be forced to:
- Credit the balance to your customer once you complete the job under budget or the client cancels the contract.
- Forward the billing for extra work.
- Shows your customer the value of your work first to justify the advance billing.
Learn how the process works before you send the prepayment bill to your customer or receive the upfront payment. Understanding the process will help you manage and account for the invoiced advance payment.
How advance payment invoicing works
An invoice paid in advance is a liability to your company. To avoid the risk of overcharging and reimbursement issues, accurately estimate the cost of your customer’s project.
Once you have drafted the budget, decide whether you will consider a deposit, partial payment, or total lump sum. Share the quote and payment details with your client and give room for negotiation if needed.
If your client agrees, he will pay the upfront payment through the agreed channel. After that, you will start working on the project as agreed. When drafting a quote, there are factors you should consider for an advance payment invoice:
1. Your clients’ reputation
Every client has a history. Conducting a background check of your clients’ reputations should help pinpoint their credit history.
Background checking is vital since it will enable you to determine:
- The client’s payment trends and ability
- Whether they are worth the risk
- The realistic payment amount you should quote in your advance billing.
2. The project’s expenditure
Calculate the total cost of a project or service. The expenditure should include expenses such as:
- Cost of materials
- Total wages or salary
- Operational costs
List them and accurately estimate the cost of each expense and materials.
3. Available resources
After drafting the list, please note what you have, then remove it. Calculate the balance, then determine how much you will invoice the client. If you overcharge an advance payment invoice for clients with a good credit score and reputation, you might lose them. Most customers hate advance payment options; tread wisely.
4. Terms and conditions
Coming up with terms and conditions for advance billing creates a better understanding between you and your client. It protects all parties in case of disputes.
Accounting for advance payment invoicing
Journal every business transaction in account records such as general ledgers and cash books. Failure to follow the accounting standards for journaling advance payments may lead to confusion, undetected fraud, and unimpressive audit reports.
There are crucial steps you should follow to avoid making errors when journaling your entries:
i) Qualify the transaction
Determine the type of transaction that took place. There are two types of advance payment:
- From a customer
- Payments made to service providers.
ii) Create an account for each type
In a general ledger, create two accounts for every transaction as follows:
- Account receivables to record it as a regular invoice payment, which means it will appear in the AR aging report.
- Deferred income accrual account, with the accrual part doubling up as a credit memo, debiting the deferred revenue account.
To avoid confusion, update the customer’s account and supplier’s account for every recurring payment they make.
iii) Account for the transaction
When journaling advance payment invoices, there are four entries you should keep in mind:
- Debit the advance payment you receive from your customer in the account receivables
- Credit the revenue generated to the revenue account. Earned income is recognized when you have delivered the purchase orders.
- Unearned revenue recorded under the unearned income line item in the balance sheet is a debt, making it a liability.
- Credit accounts payable is the advance payment you make to suppliers.
- Debits increase your expenses while credits decrease your current liabilities. Therefore, debit the cash account and credit the customer’s advance payment for the same amount.
iv) Make a report
Record the advance payments made, based on the type, on either your company’s balance sheet or income statement.
Why you should keep invoice factoring on the table
Not all business owners can afford to pay in advance, and insisting on it will only pile up outstanding invoices. An advance payment of the invoice amount will eat into their working capital, so try receivable financing or merchant cash advances.
Unlike advance invoicing, invoice financing is a type of financing where a factoring company provides a short-term line of credit for unpaid invoices. In short, the lender will advance the invoice amount even when you’ve sold goods on credit. On the due date, they will chase after the repayment.
Resolve is a business financing company offering accounts receivables solutions and net terms management. They will check the viability of a customer, determine how long their net terms should be, offer business credit, and collect payments.
Final word – why you need advance payment invoicing
In an environment where small business owners on average receive payments 30 days late, it makes sense to demand advance payment for future service or goods supply.
With advance payment invoicing, you send the client an invoice in advance and require them to make payments before supplying goods or services. That way, you eliminate late payments.
If requiring customers to make advance payments is proving a tall order, visit Resolve today for more information on B2B payments and net terms management.