Advance Payment: Meaning & Definition

KEY TAKEAWAYS

• Advance payments protect businesses and customers from potential non-payment or non-delivery.
• An advance payment requirement might be a regular practice or could only apply to specific cases. 
• It helps business owners improve cash flow, reduce loss from custom products and fulfill large orders.

What Are Advance Payments?

Advance payment is a general term used to describe any funds received by a business ahead of them providing a good or service. It acts as a protection for businesses and the customer in the event of non-payment or non-delivery. It can be used in a multitude of different industries and situations. 

Advance payment allows the business to improve cash flow, manage capacity levels, and give assurance that full payment will be received upon completion. It can be used as a standard for all the transactions within a business or it might be used for specific cases.

Typically it’s either requested as part of a business contract agreed on by both parties where a partial amount is due by a certain date. Advance payments might also be required before getting the receipt for goods and services. When the advance payment is received, the business owner puts the amount towards the outstanding balance of the product or service. Then the remaining balance is due upon receiving the items or completing the work.

How Are Advance Payments Used?

Businesses that require these types of payments are often looking to minimize the risk of unpaid invoices from customers. So you’ll likely see them used in situations such as: 

• Working with customers who have bad credit or a history of late payments
• Processing very large orders in a business with limited capacity
• Custom made products that can’t be resold 

In these situations, having a partial or full payment ahead of supplying the goods minimizes the risk to the business owner of losing money from an unpaid order. For larger orders that are outside of the normal business capacity, the advance payment provides upfront capital that’s used to purchase the supplies needed to fulfill the order. It can also discourage backing out of the purchase which makes inventory and other production factors more predictable. 

You’ve likely seen or paid an advanced payment before without realizing it. It’s common to see this type of payment made in the following industries: 

• Insurance companies charge a monthly premium in exchange for coverage even if you don’t need it right now. 
• Prepaid cell phone services. If you don’t make payment for cell services in advance, you can’t use the phone.
• Freelancers or independent contractors who require half of their fee upfront for work that’s set at a later due date
• A lawyer on a long-term case requiring a monthly retainer 

These are also great protection for a customer as well. If you’re not satisfied with the products or services provided, you can request a refund of the advance payment instead of losing the entire balance until the refund is processed.

Summary

Overall, advance payments help business owners mitigate their risk in certain scenarios by requiring payment upfront. This allows them to cover the costs associated with the order, reduce losses and improve cash flow.