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Advance Payment

What is advance payment?

When a buyer pays an amount to the seller even when the product or service has not been delivered, this safeguards the seller from the risk of non-payment and helps them to improve their cash flow. It also helps manufacturing units to manufacture products with their own funds or without taking any loan for it. Generally, advance payment is required when the buyer has a history of non-payments in the past.

Simply put,  advance payments are usually a percentage of the total contract value, and the remaining balance is paid upon completion or delivery of the goods or services.

Advance Payment Explained

Advance payments refer to monetary transactions in which a buyer remits a certain portion of the total contract value to the seller before the actual delivery of goods or services. This financial practice serves as a safeguard, mitigating the risk of non-payment for sellers while bolstering their cash flow. Additionally, it empowers manufacturing units to fund their production processes without relying on external loans. Typically, advance payments constitute a predetermined percentage of the overall contract value, with the remaining balance due upon the successful completion or delivery of the contracted goods or services.

These payments stand in contrast to deferred payments, where goods or services are provided first, and payment follows subsequently. An illustrative example of deferred payments is the monthly compensation received by an employee for work completed during that specific month.

From an accounting perspective, advance payments are recorded as assets on a company's balance sheet. As these funds are utilized, or services are rendered, they are recognized on the income statement during the relevant accounting period.

Advance payments commonly find application in two scenarios: as a prepayment made before the contractually agreed-upon due date or as a prerequisite for obtaining the requested goods or services. This financial arrangement offers benefits to both buyers and sellers, enhancing financial security and ensuring a smoother business transaction process