Accepting advance payments: What is advance billing and when to do it

One of the biggest risks businesses take is providing goods and services without payment. While businesses often do things this way, that doesn’t mean there isn’t another option. Instead, you could choose to require advance payments for your goods and services, or just for certain projects.

Advance payments are a way to reduce your risk and ensure you have the capital you need to do your work. This could be invaluable if you're one of the 46% of small business owners in our Small Business Insights Survey experiencing cash flow problems. However, if you are going to accept advance payments, you’ll need to account for these deposits or full payments correctly.

If you’re interested in trying this billing method, but don’t know where to start, we have you covered. In this guide, we’ll cover what advance billing is, the benefits of this billing method, and how to process advance payments.

Jump to:

• What is an advance payment?
• How do advance payments work?
• Advance billing vs. billing in arrears
• How to account for advance payments
• How to accept advance payments
• Tax implications of advance payments
• Pros and cons of advance payments
• Common challenges with advance payments
• How to accept advance client payments with QuickBooks Online

What is an advance payment?

An advance payment is a type of payment made before a service has been rendered. With advance billing, invoices are sent to clients before the project is completed. Advance payments can be a deposit, partial payment, or full lump sum. 

For example, progress payments are partial payments for work completed so far that can be a type of advance payment.

There may be several reasons for charging advance payment:

• To cover the cost of materials required for a project with large out-of-pocket expenses
• To act as insurance for especially larger orders
• To reduce a company’s risk of nonpayment
• To allow customers to reserve goods on preorder
• The customer requests to pay upfront—may be the case if they use cash-basis accounting or want a transaction included for this tax year

Examples include selling gift cards that can be redeemed once your business reopens or selling tickets that will be redeemed later for future events.

How do advance payments work?

To collect advance payment, your business will need to estimate the budget for the goods or services being purchased. It’s important to be as accurate as possible because it will reduce the risk of overcharging and having to issue a refund or reimbursement. This is especially important when scoping out a project.

Once you send the invoice and receive payment from the client, you’ll need to record the transaction.

We’ll cover more about how to account for and process payments later.

When do small businesses benefit most from advance billing?

Advance billing is most beneficial when your business model involves making a significant financial commitment before the work can begin.

For example, that often includes companies in industries like construction, manufacturing, and software development, where you must invest heavily in materials and labor upfront to complete each project.

These types of businesses frequently use advance billing structures, though they may have to provide advance payment guarantees to convince certain clients. These contract clauses explicitly state that the client will get their advance payments back if the vendor fails to deliver.

Here are some other signs that indicate advance billing might be a good fit for your business:

• You regularly experience cash flow challenges due to slow-paying customers
• Many of your business’s projects take multiple weeks, months, or even years to complete
• You have a low personal tolerance for the risk of non-payment for your products or services

You can use tools like QuickBooks Online to streamline advance billing workflows, such as progress invoicing.

Advance billing vs. billing in arrears

There are two general options for billing clients: advance billing and billing in arrears. Advance billing is when you invoice a customer before the service or work is complete. Billing in arrears is when you bill a customer after the work is complete.

Depending on your business and preferences, one billing method may be better suited for you over the other. Each billing method has its own advantages and disadvantages. 

Let’s take a closer look at the differences between advance billing and billing in arrears:

• Startup capital: By billing in advance, you have capital to put toward the project. However, some customers are not comfortable paying upfront when they haven’t seen the finished product.
• Building trust: With billing in arrears, you can prove the quality of your work before requiring payment. In this way, billing in arrears is an easier way to build trust with your clients. However, you also have to put trust in clients to pay their bill.
• Invoicing considerations: With advance billing, you don’t have to worry about following up for payment. However, if additional work or materials are needed, you’ll have to charge the customer on a separate invoice, meaning you won’t get paid until later.
• Issuing refunds: With advance billing, you run a higher risk of having to issue a refund. This can be the case when a client cancels a job before it’s completed or when it’s completed for less than the original quote. 

When deciding which billing method is best, consider these differences and the type of services you’re providing. Typically, advance billing is better suited for recurring clients with repetitive projects, while billing in arrears is better for one-off projects that may change.

You may even choose to start with billing in arrears for the first payment, then switch over to advance payment for future projects. This may be a valuable part of client relationship building.

How to account for advance payments

Depending on whether you are making or receiving advance payment, the accounting process is different. We’ll cover both instances below.

When you receive an advance payment from a client

When you receive an advance payment from a client, you will record it as a liability. To do this, you will need to debit the cash account and credit the liability account. Then, once the job is complete or goods are delivered, you will complete revenue recognition. This is done by debiting the liability account and crediting the revenue account.

Unearned income is recorded on the balance sheet. Once goods or services are rendered, this amount can be transferred to the income statement as earned revenue.

When you make an advance payment to a supplier

Advance payments made to suppliers are recorded as a prepaid expense on the balance sheet—as long as your business uses the accrual accounting method.

How to accept advance payments

Accepting advance payments can be much more complex than billing in arrears. Not only does it involve additional risks, such as the potential for overcharging clients and having to issue refunds, but the accounting requirements are also more involved.

If you are going to accept prepayment, here are a few guidelines to follow:

1. Consider whether advance payment is the best course of action for certain clients/projects.
2. Use online invoicing software to manage invoices—with QuickBooks Online, you can create, send, and track invoices.
3. Allow for online invoice payments. With QuickBooks Payments, once a pay-enabled online invoice is paid, it can be automatically added to your books.
4. Pay attention when doing your accounting to ensure that you are correctly attributing revenue from advance payments.
5. Shift advance payments to revenue instead of using a reversing entry to account for these transactions.

Tax implications of advance payments

Accepting advance payments can have significant tax implications for your business. To avoid compliance issues and other potential complications, you need to understand the rules. Here are some of the most important ones to be aware of:

• Revenue recognition standards: If you use the accrual basis of accounting, you can’t recognize advance payments until you’ve earned them under the terms of ASC 606 or IFRS 15, depending on where your business operates.
• Sales tax regulations: The timing of sales tax obligations for advance payments vary between jurisdictions and products. For example, some areas may require you to collect taxes when you receive payment, while others won’t until you deliver the goods.

Revenue recognition and sales tax rules are complex, and the penalties for non-compliance can be steep. Tools like QuickBooks Online Advanced include automatic revenue recognition features, but it’s often still highly beneficial to consult a tax professional for guidance.

Pros and cons of advance payments

While getting your money upfront might seem like it will only benefit your business, there are pros and cons to advance payments.