Prepayment
Payment made before goods are delivered or services are rendered.
Definition
Prepayment is payment received before the associated goods or services are provided. This includes deposits, advance payments, and full payment upfront. Prepayment transfers financial risk from seller to buyer, as the buyer has paid for something not yet received.
From an accounting perspective, prepayments received are liabilities until the goods/services are delivered—the business owes the customer until they fulfill their obligation. Revenue is recognized as the obligation is fulfilled.
Why It Matters
Prepayment dramatically improves cash flow and reduces collection risk. You have funds in hand before incurring costs to fulfill the work. For new clients, high-risk orders, or custom work, prepayment reduces the risk of non-payment after investing time and resources.
The trade-off is that customers may resist prepayment, preferring to pay only after they receive value. Offering partial prepayment (deposits) balances seller protection with buyer comfort.
Examples
- 1
A custom furniture maker requires 50% prepayment before starting production, with the balance due before shipping.
- 2
A SaaS company offers a 10% discount for annual prepayment instead of monthly billing.
- 3
A consulting firm requires a retainer (prepayment) to be established before beginning work for new clients.
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