A payment made, or the money received, for goods or services before its delivery. Sellers may require an advance to protect against nonpayment or cover the out-of-pocket costs for delivering the goods or services.
How Advance Works
Advance, also known as an advance payment, is when sellers may require an advance to help cover production costs, especially for highly customized goods, or when a paying party has a low credit score. The manufacturer then adds the balance, if any, to the invoice sent with the goods, which the buyer pays upon delivery. When a buyer pays an advance for goods or services, the seller records it as a liability because they haven't carried out any action yet. When the seller receives an advance, the buyer records it as an asset since they haven't received or consumed any product. These payments are opposed to payment in arrears - or deferred payments. In these cases, the seller delivers a good or renders a service, and the buyer pays after.
Generally, you can make advance payments in two situations.
- You can make an advance before a contractually agreed upon due date.
- You can make an advance payment before receiving the requested goods or services.
As a buyer, advance payment is a form of insurance, assuring that if the seller fails to meet their obligation of delivering the goods or services, they can ask the seller to refund the advance. This protection gives them the right as a buyer to consider a contract void if the seller fails to fulfill their end of the transaction, reaffirming their rights to the initial funds. Companies sometimes pay an advance to sellers when they make large orders that the manufacturer may find burdensome. This helps protect the manufacturer if the company decides to cancel the deal before delivery.
As a producer, an advance can help fulfill large orders when you do not have enough capital to buy materials, as you can use part of it to pay for the products you will be creating. It is also an assurance that you will get a certain amount of revenue when you complete the large order.
Examples of Advance
As consumers, we pay in advance more often than you may think. Below are two common examples of an advance.
You own a large company that makes wooden chairs for schools and offices. A private school wants you to produce and deliver 650 wooden chairs to their new school located in the neighboring town in just under six months. To meet the deadline, you ask for an advance to help cover part of the production cost, additional labor hours. With the advance, you are more confident that the new school will not back out of the deal before final delivery.
Another example of an advance is when you make an order for 25 pizzas for your son's 12th birthday party. Since the order amount is larger than usual for the pizza place, they ask that you pay half of the total bill before delivering the order.