Advance Invoice in New Zealand
An advance invoice is issued when the customer is required to pay before goods are delivered or before the performance of services. Depending on the policy and understanding, the payment request via the advance invoice can be partial or full. There are also different forms of an advance invoice which include the following:
- An invoice which requests for the full payment before the commencement of work
- An invoice that requests payment for milestones in advance
- An invoice that requests payment for a certain percentage of the total invoice before the work is done
When is an Advance Invoice Used?
An advance invoice is generally used in the following situations:
When the risk of non-payment from the customer is higher
The use of an advance invoice is practical in the situation where there is a likelihood that the status of the business of the customer is skeptical. There may be an uncertainty about the going concern status of the customer’s business. This riskiness means that it will be wise to use the advance invoice as it may be difficult to place reliance on startups or businesses that are struggling with finance.
Stock to be sold is highly specialized / bespoken
For businesses that are producing bespoken or highly specialized goods, it may be a good idea to issue advance invoices to their customers as these specialized products are useful for a limited group of people only. In the event of a customer not accepting the order after production, this can cause potential great strain and financial loss for the business as it is harder to locate other buyers for those specialized goods from the general public. Hence, an advance invoice will be useful in this situation.
Bargaining power of the seller is higher
Generally advance invoices can only be exercised when the seller has higher bargaining power along with lower competition. If the seller operates in a saturated industry, other competitors may offer credit in order to attract potential customers. For this reason, advance invoices are usually issued in industries where the bargaining power of the supplier is higher.
The upfront cost to fulfill an order is higher
In industries where the cost to complete an order is higher, an advance invoice could be utilized. If the advance payment is not received, the seller may be put in a position to raise expensive finance and this will compromise on their profitability.
Recurring revenue/subscription-based business model
In a subscription based business model, the use of advance invoices is prolific as it is highly convenient. It creates clarity and ease for the customer so that they can make prompt payment on a timely basis.
Lengthy trade processes
In some businesses, it may take months and years for the supplier to manufacture products. In addition, they may need to continually incur expenditures in the manufacturing phase. In this situation, an advance invoice would be considered a blessing as it helps to relieve the burden on the working capital structure of the business.
Profiles of Companies Where an Advance Invoice is Used
Airbus
At the time of accepting an order, Airbus requests up to 50% advance of the total price of the aircraft. The prime reason for this requirement is that there is a massive cost that is involved in the manufacturing of an aircraft. One of their products, such at the smaller A220, has a list price of $81 million. If we apply the company’s latest gross profit margin of around 18%, the cost of sales for a single, stands at $66.42 million ($81*82%). If Airbus did not charge the higher initial deposit, they would be in a precarious position where they will be required to raise finance and pay the cost of finance, thereby compromising on their ability to earn profit.
General Contractors
Usually General Contractors send staged invoices to their customers. For instance, at the start of construction, they will send an advance invoice for items such as demolition, foundation concrete and others. Once the foundation is complete, another advance invoice is sent for framing, hardware, heating, ventilation and overall structure of the building. Lastly, they ask for an advance payment to finalize construction by charging for items such as tiles, showers, heating systems, air conditioners, kitchen cabinets, vanities and so forth.
Inv24
With our company, the user is required to make an advance payment in order to access our Premium services. The advance invoice works well here as we are a subscription-based revenue model that makes it convenient and easy for customers to make payment.
As has been discussed, the use of advance invoices can be highly effective in certain situations. However, there are both advantages as well as disadvantages of using advance invoices which will now be discussed.
Advantages of an Advance Invoice
Following are some advantages related to the use of advance invoices:
Significant reduction in the risk of non payment
Especially in the case of customers that are new, it is difficult to place reliance on them because they do not come with a trade history. The company will be taking a risk because in order to fulfil those customer’s orders, it requires a certain amount of cost. That is why it is safer for the seller to collect an advance before working on their orders. Depending on the understanding between the seller and customer, this collection can be a partial or a full advance.
Higher efficiency in working capital management
Because the payment is received in an advance invoice, the funds can be used to cover the cost of sales, operating expenses and other business related expenses. This shows that advance payments have a significant potential to enhance working capital. If the advance payment is received, there will be limited or next to no need to raise overdrafts or short-term finance, which is expensive working capital.
Optimization of administrative resources
Chasing debtors can be difficult, expensive as well as irritating. Big businesses and companies are able to collect funds though their dedicated departments and staff. However, this is still a highly expensive and complicated process. Nevertheless, an advanced billing system eliminates the need to incur the cost for the function of debt collections.
Simplified automation
Advance payment helps to enhance the overall process by making it simple and efficient. To make payments, customers do not need to wait for the delivery of goods. This means that they can automate transactions without waiting for delivery.
Streamlined recurring payments
By streamlining recurring payments, it leads to enhanced automation and also increases process efficiency. This is due to the fact that in the case of recurring services, an advance invoice will bring clarity to the amount and payment terms.
Ease in setting a budget
In most situations, the final amount for the products or services will be written on the advance invoice. Since this amount will be more reliable than estimates, its helps in the reliability of the expenditure budget from the customer’s perspective.
Disadvantages of an Advance Invoice
Following are three disadvantages of advance invoices:
Enhanced refund hassles
If a project were to get canceled, the business will be required to issue a refund. This event of refunding, not only creates inconvenience but also leads to an impairment of the working capital structure the business.
Complication for separate charges
For sellers, it becomes difficult to charge the customers extra if they have already collected payment in advance. If there is a need to make extra charges, an issue of a new additional invoice will be required. These kinds of incidents may cause some conflict in the business relationship between the seller and customer.
Higher uncertainty from a customer’s perspective
After making an advance payment, the customer may be faced with a situation in which they have express concerns about the final delivery’s quality, time or other aspects. That is why the supplier needs to place more effort in trying to satisfy the customer.
It is important to note that an advance invoice is an opposite version of an invoice in arrears. In arrears, the customer is required to pay once the goods have been delivered or the services have been performed. An arrears invoice, creates a receivable in the financial statement, which is an asset. This is contrasted to an advance invoice as it creates unearned revenue or deferred income, which is recorded as a liability in the financial statement of the business.
How to Create an Advance Invoice
Method 1: Use our simple invoice software
Method 2: Download a free advance invoice template:
Accounting for an Advance Invoice
Now we shall discuss the detailed aspects of accounting for payment and receipt of an advance invoice.
Accounting for an advance invoice is different from a customer and supplier perspective. Both these situations will now be discussed.
Journal Entry for Invoice Received in Advance (Customer Perspective)
The following journal entry is posted in the accounting books when the customer pays an advance invoice:
| Details | Debit | Credit |
| Advance/deposit | XXX | |
| Cash | XXX |
The debit impact of the transaction creates an asset in the financial statement because the customer has not realized the economic benefit of this payment. On the other side of the transaction, the credit impact reduces cash from the books as it has been paid.
Once goods are delivered, the following entry is posted in the books:
| Details | Debit | Credit |
| Goods/Inventory | XXX | |
| Advance/deposit | XXX |
The debit impact of this transaction is that goods are recorded in the books as the goods have been received. On the other hand, the credit impact removes the deposit or advance, which was recorded in the previous journal entry. The reason for the removal of the deposit or advance is that the economic benefit in the form of goods has been realized. This means that there is no need to keep the deposit or the advance in the books of accounts.
Journal Entry for an Invoice Issued in Advance (Supplier Perspective)
The following journal entry is posted it the accounting books when the supplier gets paid against the advance invoice:
| Details | Debit | Credit |
| Cash | XXX | |
| Unearned revenue | XXX |
The debit impact of this transaction is to record the cash receipts. On the other hand, the credit impact is the recording of a liability as the business has entered into an obligation to fulfil certain commitments.
Once the commitment of the delivery of goods or performance of services, has been fulfilled, the following entry is recorded:
| Details | Debit | Credit |
| Unearned revenue | XXX | |
| Revenue | XXX |
The debit impact of this transaction is to remove the liability or obligation. This is because the business has fulfilled its commitment to deliver economic benefits. On the other side of the transaction, the credit impact is the recording of revenue under normal accounting procedures.
It is of particular importance to not confuse the advance invoice with a proforma invoice. The following table will outline the difference between the two.
Difference Between an Advance Invoice and a Proforma Invoice
| Advance invoice | Proforma invoice |
| An advance invoice is a requirement to pay. It creates a demand to pay before goods are received or services are performed. | A Proforma invoice is not a requirement to pay. Instead, it is just a proposal that aims to build a sales contract between the seller and customer. |
| An advance invoice is expected to positively contribute to the working capital management of the seller. | Proforma invoice does not have any impact on working capital management. |
| An advance invoice acts as a source document to post transactions in the accounting system. For instance, funds received from customers are debited, and unearned revenue is credited to the accounting system. | No updates are required in the accounting system for proforma invoices. |
| Usually, an advance invoice is issued when terms and conditions have already been agreed between the seller and buyer. | The customer has the option to negotiate the terms and conditions mentioned in the proforma invoice. They may accept, request some changes, or reject completely. |
Can a Business Receive a Full Advance Payment?
Yes, a business will be able to receive a full advance payment using an advance invoice. This will depend on the business understanding between the seller and the buyer.
Conclusion
An advance invoice is issued by the seller when the customer is requested to pay before the goods or services are delivered to them. Depending on the understanding and business terms between the seller and buyer, the advance invoice can be used to request partial or full payment.
An advance invoice is generally used when there is a higher risk of non-payment by the buyer, the stock sold is highly specialized and bespoken, the upfront cost to manufacture the goods is higher, when the business model is based on recurring revenue or there is an extensive length of trade process. As highlighted above, General Contractors, Inv24 and Air Bus are profiles of companies that use advance invoices as part of their business operation.
The advantages of using advance invoices include, a significant reduction in the risk of non-payment as the selling business has collected the funds before fulfilling the commitment and higher efficiency in working capital as there is little or no need to raise short-term time finance once the business receives that advance payment. In addition, there is optimization of administrative resources as the seller does not have to follow up for collection of funds. Simplified automation and an ease in setting a budget are also advantages as the terms are clear from the start.
In addition to the advantages of using an advance invoice, there are certain limitations involved also. This includes higher customer uncertainty about the quality and delivery of goods. This is because the customer has already paid for the goods before inspection. From the seller’s perspective, it can be difficult for them to collect additional charges if they need to because customers may not want a second invoice for additional charges once they have already paid. Another disadvantage is that it is difficult for the seller to issue a refund in the case of when the buyer cancels an order.
Accounting for an advance invoice is straightforward. From the customer’s perspective, the payment made is an asset and is adjusted when the seller fulfills their commitment. From the seller’s point of view, the advance received is a liability and is adjusted when the obligation is fulfilled.
It is important to note that a proforma invoice is different from an advance invoice. For instance, an advance invoice is used to request payment before the work has been performed or goods have been delivered. The payment received is accounted for in the accounting books. On the other hand a proforma invoice is an estimate only and is sent with the intention to communicate terms and conditions of the sales contract that may be agreed upon.
Frequently Asked Questions
How is the advance payment received reported in the financial statement of the business?
An advance payment received is reported as a liability in the financial statement of the business. This account balance for liability is called unearned revenue or deferred revenue. Once the work is performed, the liability is removed and revenue is recorded in the financial statement of the business.
What is the impact of an advance invoice on working capital management?
There is a positive impact of an advance invoice on working capital management. The amount received from advance payments from customers can be used to pay suppliers, contractors, vendors and so forth. In this case, there is little or no need or pressure to raise short-term finance, which is an expensive source of working capital.
What is the different between an invoice in advance and an invoice in arrears?
Invoice in advance is when the customer is required to make payment before the goods are delivered. On the other hand, invoice in arrears is when a customer is required to make payment after goods have been delivered to them.
Is there any risk associated with an advance invoice?
The prime risk associated with an advance invoice is that the seller may fail to fulfill their commitment and may not be able to deliver quality goods as promised.
Is deferred income the same as advance payment received from the customer?
Yes, deferred income is the same as advance payment received from the customer. It is recorded as a liability and is adjusted when the obligation is fulfilled.
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