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What is Advance Billing?
Advance billing is the action of sending a customer an invoice before the delivery of goods or services. In advance billing, customers pay for goods and services before they receive them, rather than waiting until after services have been rendered.
The amount required for an advance payment could either be a percentage of the total as a down payment or the full amount of the bill.
Advance billing payments are often required by companies that provide service contracts, such as repair technicians or software maintenance providers. It is also common in businesses that require large upfront payments for services such as construction projects, B2B manufacturing, legal fees, and medical procedures.
This billing method is beneficial for companies with longer project life cycles, or those that need upfront to cover costs associated with the services provided. It also provides an extra layer of security when dealing with customers that have poor credit or might default on their payments.
- Advance payment invoice
- Invoicing in advance
- Upfront billing
Advance Billing Examples
Types of advance payments include:
- Down payment: A percentage of the total service cost. It can be requested before any services begin, and is usually nonrefundable if the customer decides to back out of the agreement.
- Deposit: Similar to a down payment, a deposit is given by the customer to secure their commitment to the service.
- Progress billing: An invoice sent based on the completion of a specific amount of work. It’s common in construction and software projects where progress payments are made throughout the project life cycle.
- Prepayment: The customer must pay the total amount before any services are rendered. This is often used for large projects that require considerable resources and effort from a company.
- Recurring payments (retainers): Buyers make regular payments at specific intervals, such as monthly, quarterly, or yearly. They can be used to establish a payment plan for customers with ongoing needs.
- Partial payment: The customer pays for part of the services upfront and then make regular payments until the balance is paid off.
- Seasonal billing: Some companies ask customers to pay before a busy season for a product or service that will be provided during that season. For instance, lawn mowing companies sometimes require payment in advance for the frequent mowing needed during a particular season.
Why Implement Advance Billing?
Invoicing in advance offers several benefits to companies:
- Easier to automate. Advance billing is much easier to automate than traditional billing. This automation can reduce the cost of processing payments and enable more efficient customer service.
- Immediate cash flow for businesses. If a company’s services entail a high cost of good sold (COGS), advance billing can provide them with the cash flow needed.
- Better revenue forecasting. Forecasting of cash flow is difficult for service and project-based businesses, and advance billing can help them plan their finances better.
- Enhanced customer relationships through flexible billing options. An advance payment structure can help companies build stronger relationships with customers by providing them flexibility in how they pay for goods and services.
- Improved customer retention. When customers have already made a commitment through advance billing, they are more likely to complete the purchase, despite any difficulties that might arise in the course of service delivery.
- Timelier payments. Advance billing gets businesses paid faster, sothey don’t have to worry about the dunning process later on.
- Reduced chances of defaulting payments. Sending invoices to customers ahead of time helps businesses avoid bad debt, and puts their finances on a more stable footing.
Benefits of Advance Billing
The main benefits of advance billing are its ability to eliminate risk, increase cash flow, and ensuring payments.
Especially when advance billing is part of subscription models, it helps companies reduce the risk of not getting paid. Companies with subscription models may be dependent on recurring revenue, so it’s important for them to ensure they receive payments from customers regularly.
Increases Cash Flow
Advance billing reduces days sales outstanding (DSO), meaning businesses get their money faster and can use it to fund operations or launch new projects.
Businesses with high operating expenses, such as construction companies, can’t operate without upfront customer payments—part (or all) of them go towards paying for materials, labor, and other overhead costs.
No Chasing Late or Non-Payments
An advance billing invoice establishes trust right from the beginning. Since a customer must invest some money upfront, they are more likely to honor the agreement and complete the purchase.
This eliminates the need for a company to chase overdue payments or take legal action, reducing administrative and financial costs.
Challenges With Advance Billing
Advance billing entails some risk to buyers, so it can be difficult for companies to get customers on board.
Challenges associated with advance billing include:
- Buyer hesitation. Clients may be reluctant to pay for a service (or trust its provider) before it has been produced or delivered, leading to resistance to adopting advance payments.
- Refund complexities. Handling refunds after invoicing customers in advance can be challenging, as businesses may have already invested time and resources into partially completed projects when a refund request is made.
- Unanticipated costs. Should the production or delivery of goods or services demand additional time or resources, supplementary invoices may be necessary, complicating the payment process and causing potential delays.
- Cash flow management. Companies that implement advance billing may face difficulties in managing cash flow, as they must accurately allocate and track funds received for future expenses.
- Legal and regulatory considerations. Businesses must ensure that their advance billing practices comply with relevant laws and regulations, which may vary depending on location and industry.
- Communication challenges. Clear and transparent communication is essential in advance payment scenarios, as misunderstandings regarding payment terms or project progress can lead to low customer satisfaction and high rates of disputes.
Advance Billing Management
Receiving and accounting for advance payments requires accurate recordkeeping, and companies should establish processes to keep track of all payments received. It requires greater oversight since it involves revenue earned and received in different accounting periods.
How is Advance Billing Organized?
Typically, an advance billing invoice comprises two separate parts: accounts receivables (AR) and accruals.
- Accounts Receivable (AR): The advance billing’s AR section will appear on your AR aging report and function like an ordinary invoice, but it won’t credit any revenue. Instead, the amount will be added to your company’s specified unearned income accrual account.
- Accruals: Accrual-basis accounting records revenues or expenses that have been earned or incurred but have not yet been included in the company’s financial statements. Like credit memos, advance payments are treated as assets on the balance sheet.
Essentially, the unearned income accrual account is a placeholder for advance payments until customers are invoiced and billed.
How to Determine the Type of Advance Payment
Determining the type of advance payment gets complicated if some or all of certain project deliverables have been completed or if it’s part of an ongoing service.
Additionally, some advance payments are non-refundable, while others may be refunded if the customer is unsatisfied or tries to cancel their contract. If conditions have changed since the initial agreement, a business may also need to reconsider its terms.
In general, there are two primary advance payment types that go on accounting records: earned and unearned revenue.
- Earned revenue: Earned revenue describes revenue for jobs completed completely or partially but have not been invoiced for. It is recorded in the general ledger as deferred revenue and must be recognized when the invoice is sent for payment.
- Unearned revenue: Unearned revenue records payments made in exchange for services yet to be provided or delivered. It is also recorded in the general ledger as deferred revenue, but it must be recognized when the related services have been performed.
To clarify, businesses must set up a deferred revenue account to account for deferred billing. The initial customer payment is considered a liability, as they still owe them a product or service.
Accounting for the Advance Payment
To log the advance payment in your financial records, increase the cash account by debiting it and simultaneously credit the customer deposits account for an equal amount.
Keep in mind that debits boost expenses, assets (such as cash or equipment), and dividend accounts, whereas credits reduce these accounts and elevate liability and equity accounts for your business.
Once the products or services have been fulfilled, invoice your client if they still owe any remaining balance.
Revenue recognition occurs in the period the services are provided and the customer has settled their payment, not solely at the time of initial receipt.
Lastly, document the entire transaction in your accounting journal with the following entries:
- Credit to revenues
- Debit to accounts receivable
- Debit to customer deposits
Reporting Advance Payments on Financial Statements
During the accounting process, advance payments will be documented on either the balance sheet or the income statement, depending on the payment classification.
For unearned revenue, this sum is recorded on the company’s balance sheet as a liability under the unearned revenue category.
Earned revenue is documented on the income statement once the corresponding invoice has been issued.
Upon issuing the invoice, the transaction can be finalized in your financial records. Unearned revenue is transferred from the balance sheet, as it is now considered payment for an invoice and included in the accounts receivable for that specific period.
Simultaneously, earned income is shifted from a pending line item on the P&L statement and applied to the outstanding amount of the invoice.
Billing Automation for Advance Billing
Billing software can detect what type of advance payment was made and generate customer invoices for those who need to pay out their remaining balance.
Another critical benefit of billing automation is its ability to handle payment processing—one of the biggest causes of cash flow problems for businesses.
Automated billing systems can determine when customer payments have been approved and automatically send invoices, ensuring customers receive a payment reminder without worrying about dunning management.
People Also Ask
What is the difference between advance billing and billing in arrears?
The main difference between advance billing and billing in arrears is when the invoice is sent to the customer. Advance billing involves sending an invoice before services have been provided, while billing in arrears requires that services be completed before invoicing customers.
Is advance billing an asset or a liability?
Advance billing is considered an asset if the services have been provided, but a liability if the services have not yet been completed. If an advance payment is earned within a year (which it usually is), it is listed as a current liability. Whenever a customer makes an advance payment, it is debited to the Cash account on the balance sheet.
What is the opposite of advance billing?
Deferred billing—also known as post-billing, invoice billing, or arrears billing—is the opposite of advance billing. With deferred billing, customers pay for products and services after they have received them. Deferred billing is sometimes used to accommodate businesses that don’t have cash available upfront.