Managing cash flow is critical to your business, and understanding your options for billing your customers and recognizing that revenue is key. One way many businesses bill customers is with advance billing. Advance billing is when you invoice your customer prior to providing a service or job.
There are many reasons you might choose advance billing over billing in arrears.
- Easy to automate the billing process
- Cash is in-hand before the job starts, providing start-up capital if needed
- Less stress on collections since payment is upfront
- Immediate credit established for new customers
- Schedule and payments regularly up to date for recurring services
There are some detractors to advance billing to keep in mind, especially if this is a new approach for your business and customers:
- You may need to issue a refund or credit if job is completed under budget or canceled prior to completion
- Additional charges will have to go on the next invoice - extending billing for extra work
- Customers are sometimes deterred by upfront billing, wanting to see value first
How is advance billing managed?
The advance bill invoice essentially allows you to take in a payment from your client and over the course of the service, recognize revenue by associating regular invoices. This allows you to recognize the income and expenses for the project within the same general ledger period.
The advance bill invoice typically has two separate parts: 1) AR part, and 2) accrual part.
The AR section of the invoice acts like a regular invoice, meaning it will show on your AR aging report. But instead crediting a revenue account, it will post to your designated deferred income accrual account.
The accrual part of your invoice acts like a credit memo. You are applying your regular invoices against the initial payment that was received. In this case, your regular invoices will not post with a debit to AR, but instead a debit to your designated deferred revenue account.
Under the accrual basis of accounting, revenues received in advance of being earned are reported as a liability. If they will be earned within one year, they should be listed as a current liability.
Receiving and accounting for advance billing payments from a client requires careful attention to the way entries are made in your accounting records. The process usually involves qualifying the type of payment received, and then completing the posts to the general ledger so that once the goods and services related to the payment are invoiced, that payment can be applied properly. Some general steps to keep in mind are how you determine the type of advance payment, how you account for it and how you report it.
Determine type of advance payment
First, qualify the type of advance payment. This depends on whether or not the goods or services have been delivered.
- Earned revenue is if the payment is for goods and services that have been partially or completely delivered to the customer, but have not yet been invoiced.
- Unearned revenue is if the payment is for goods and services that will be delivered and invoiced at a future date and you have not yet provided any benefits to the buyer.
Second, create your deferred revenue account. You might think a customer deposit would be straight income, but since you "owe" the customer something, it's actually a liability to the business.
Third, associate the advance payment to the correct customer account. If this is a new client, create a customer account in the accounting records. The detail for the earned or unearned revenue should be posted in that account.
Account for the advance payment
In your accounts, debit the cash account and credit the customer deposits account in the same amount. Debits increase expenses, assets such as cash or equipment, and dividend accounts. Credits decrease these accounts and increase liability and equity accounts.
After the services are rendered, send an invoice to the customer. Invoice the amount of the deposit previously paid and subtract it from the total amount owed. Revenue is recognized when services are fully delivered and the customer has been invoiced, not when the money is received.
Next, record the transaction in your accounting journal.
- Revenues are credited
- Accounts receivable is debited
- Customer deposits are debited
Post the advance payment on either the balance sheet or the income statement, based on the type of payment.
- Unearned revenue, the amount may be posted to the company balance sheet as a liability under the unearned income/revenue line item.
- Earned revenue can be posted to your income statement once an invoice has been sent.
Once the invoice is posted, complete the transitions in your accounting books. This will move the unearned income from the balance sheet, since it can now be counted as a payment on a specific invoice and considered part of the receivables for the period.
Similarly, earned income can be moved from an outstanding line item on the income statement applied toward the balance of the invoice.
Advance billing is a smart way to manage payments from customers, especially for recurring services, but it does take some planning and attention to your accounts to ensure you are attributing the correct amounts to your revenue. This gives you better and more accurate forecasting of cash flow, which means you have reliable information on which to base your business decisions.