The Receipt of Cash in Advance from a Customer: A Guide

Receiving cash in advance from a customer can be a straightforward process, but it's essential to understand the implications and best practices involved.

Cash received in advance should be recorded as a deposit, which is a type of advance payment from a customer.

Before accepting cash in advance, businesses should have a clear policy in place to guide their staff on how to handle such transactions.

This policy should include details on how to process payments, manage deposits, and communicate with customers about their advance payments.

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Receiving cash in advance from a customer can be a game-changer for businesses, especially those with lengthy order cycles or customized orders. This payment method can alleviate the risk of non-payment and provide immediate funds for day-to-day operations.

Customer advances can be recognized as deferred or unearned revenue, meaning the company hasn't fulfilled its obligation yet. Businesses can use these advances to secure orders, cover initial costs, and mitigate credit risk.

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In general, advances contribute to a business's financial stability and healthy cash flow. They also demonstrate a customer's commitment to the transaction, reducing the likelihood of order cancellations.

Here are some common conditions where customer advances are expected:

However, managing advance payments requires extra administrative efforts, including tracking and reconciling the books of accounts for revenue recognition and customer deposits.

From the customer's perspective, cash in advance payments can be a riskier option. This is because the structure of cash in advance transactions fully benefits the seller and poses risks for the buyer.

The risks of cash in advance payments increase if the seller or network is not highly credible. Cash in advance terms can be common in online marketplaces and international trade, where buyers may not have a chance to inspect the goods before paying.

As a buyer, you may want to consider the credibility of the seller and the network they are using, to minimize the risks associated with cash in advance payments.

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As a buyer, you might be hesitant to use cash in advance payment methods, and for good reason. Cash in advance payments can be a significant risk for buyers, especially when dealing with uncredible sellers or networks.

In online marketplaces and international trade, cash in advance terms are common, but they can be a burden for buyers. The seller requires the entire payment upfront, which can be a heavy financial burden.

If you're dealing with a seller who requires cash in advance, be aware that you may not have the option to pay immediately before ownership is transferred, even if you opt for cash on delivery. Most pre-payments are made through wire services or online payment portals.

In some cases, you may be able to pay immediately before ownership is transferred, but this is not the norm. Cash in advance payments are typically fully made upfront, which can be a significant risk for buyers.

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From a customer's perspective, understanding what an advance from a customer means is crucial. It's a current liability that records all the prepayments received from buyers before the delivery or provision of their respective goods or services.

The advance from a customer is a company's liability pertaining to the money received from the client for the goods or services that are deliverable in the near future.

In simple terms, when a customer pays in advance for a product or service, the company records this payment as a liability until the goods are handed over or the service is rendered.

This liability is treated as deferred revenue until the goods are delivered or the service is provided to the respective customer.

Here are some key facts to keep in mind about advance from a customer:

In the context of receiving cash in advance from a customer, the amount is often recorded as unearned or deferred revenue in the company's balance sheet.

A customer advance can be recorded as a debit to the cash account and a credit to the unearned revenue account, as seen in the example where ABC Services Ltd. receives a $900 payment from XYZ Corp.

When a customer pays in advance, the company recognizes revenue as it fulfills its service obligation, reducing the deferred revenue accordingly. This is illustrated in the example where ABC Services Ltd. recognizes $300 of revenue each month for a service contract spanning three months.

Here's a breakdown of the journal entries made in this context:

The SAP system also provides standard functionality for advance receipts from customers, using special GL indicators and posting keys to update the customer table and special GL account.

Cash markets can be a convenient way to make purchases, especially online. Most consumers and businesses are comfortable making e-commerce purchases through well-established businesses like Walmart and Home Depot.

Online marketplaces like eBay and Amazon can be a bit riskier, especially if the businesses are less transparent. Buyers may make online cash in advance payments without much research or perceived risk.

Some online businesses, like Walmart, have a high level of transparency, which can make customers feel more secure. This is especially true for well-established businesses with a strong reputation.

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Letters of credit provide a documented obligation from a financial institution to facilitate payment for the buyer.

A fully funded letter of credit can serve as a type of escrow account, providing a documented promise that the funds are being held in a separate account for payment once shipping terms have been met and payment has been requested.

Fully funded letters of credit, which include borrowed funds, start charging the buyer interest immediately.

Unfunded letters of credit provide a documented promise that the bank agrees to make a payment for the buyer if it cannot do so itself at the time payment is requested.

Both funded and unfunded letters of credit can offer the buyer borrowed funds from the financial institution to make a payment to a seller.

Unfunded letters of credit begin charging interest when funds are dispersed if necessary.

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Let's take a closer look at some examples of how advance payments work in business.

A customer advance is often stated as unearned or deferred revenue in a company's balance sheet. This is because the revenue has not yet been earned by the company, as the service or product has not been fully delivered.

In Example #1, ABC Services Ltd. receives a $900 payment from XYZ Corp. for a service contract spanning from January to March 2024. The company records this $900 as deferred revenue by passing the following advance from customer entry in its books: Cash A/c Dr. To Unearned Revenue A/c.

As the company fulfills its service obligation, it recognizes $300 of revenue each month, reducing the deferred revenue to $600. This process repeats monthly until the entire $900 is recognized as revenue.

Some companies, like Moderna Inc., report deferred revenue in their financial statements. As of March 31, 2023, Moderna Inc. reports $1.8 billion in deferred revenue concerning customer deposits for scheduled vaccine delivery in 2023.

In Example #4, SAP provides standard functionality for advance receipts from customers by using special GL indicators. This is done by defining special GL indicators in OBXR for customers and special GL accounts, which are updated as soon as posting is done.

Here's a list of some common posting keys for advance receipts:

These posting keys are used in SAP to book customer advance receipts with special GL indicators.

To record the receipt of cash in advance from a customer, you'll need to pass a journal entry. This entry debits the cash account and credits the customer's advances or unearned revenue account.

The journal entry is made to recognize the increase in funds and indicate the obligation to provide goods or services. It's essential to pass this entry to ensure accuracy, fairness, and transparency in the books of accounts.

Here's an example of the journal entry: Cash A/c Dr. To Unearned Revenue A/c (Being advance from customer received).

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