Step-by-Step Guide: Recording Advance Payments from Customers in QuickBooks online and Desktop

Advance payments from customers are a common practice in many businesses. Whether it's for a large project, a custom order, or a reservation, recording advance payments correctly in QuickBooks—both Online and Desktop versions—ensures your financial records remain accurate. Here's a step-by-step guide to help you navigate this process.

Recording Advance Payments in QuickBooks Online

Step 1: Create a Liability Account

An advance payment is not income until the goods or services are delivered. Therefore, it should be recorded as a liability.

Log in to QuickBooks Online.

Go to Settings (gear icon) and select Chart of Accounts.

Click New to create a new account.

Select Other Current Liabilities as the account type.

Name the account something like "Customer Advances" or "Unearned Revenue."

Click Save and Close.

Step 2: Receive the Advance Payment

Go to + New and select Receive Payment.

Choose the customer who made the payment.

In the Payment Date field, enter the date of the advance payment.

For the Payment Method, select the appropriate option (e.g., check, credit card, etc.).

In the Deposit to field, select the bank account where the payment was deposited.

Leave the Outstanding Transactions section blank.

In the Memo or Reference section, note that this is an advance payment.

Click Save and Close.

Step 3: Link the Advance Payment to an Invoice

When the goods or services are delivered, create an invoice:

Go to + New and select Invoice.

Fill in the customer and transaction details.

Apply the advance payment by selecting it from the Credits section at the bottom of the invoice

Save the invoice.

Recording Advance Payments in QuickBooks Desktop

Step 1: Set Up a Liability Account

Open QuickBooks Desktop and go to Lists > Chart of Accounts.

Click Account at the bottom and select New.

Choose Other Current Liability and click Continue.

Name the account, e.g., "Customer Advances" or "Unearned Revenue."

Click Save & Close.

Step 2: Record the Advance Payment

Go to Customers > Receive Payments.

Select the customer who made the payment.

Enter the amount and date of the payment.

In the Payment Method field, select the appropriate option.

Instead of applying the payment to an invoice, leave it as a credit.

Click Save & Close.

Step 3: Apply the Advance Payment to an Invoice

When the goods or services are delivered:

Create an invoice by going to Customers > Create Invoices.

Fill in the customer and transaction details.

QuickBooks will prompt you to apply the existing credit. Confirm and apply the credit.

Save the invoice.

What Are Prepayments?

Prepayments refer to payments made by a customer before the delivery of goods or services. These payments are often used to secure orders, demonstrate a commitment, or meet contractual obligations. Prepayments can occur in various forms, such as deposits, retainers, or advance payments.

For businesses, prepayments act as a source of immediate cash inflow, while for customers, they provide assurance of service or product delivery.

Why Are Prepayments Important?

Improved Cash Flow: Prepayments provide businesses with working capital in advance, enabling them to fund operations or procure materials needed for fulfilling customer orders.

Reduced Credit Risk: By collecting funds upfront, businesses minimize the risk of non-payment or bad debts.

Customer Loyalty and Trust: Offering prepayment options demonstrates transparency and builds trust with customers.

Streamlined Operations: Prepayments help businesses better plan inventory, staffing, and production based on confirmed orders.

Steps to Apply Prepayments to Invoices

Applying prepayments to invoices can be a straightforward process if done correctly. Follow these steps to ensure accuracy and efficiency:

1. Record the Prepayment

When a customer makes a prepayment, record the transaction in your accounting system as an advance payment. This step ensures the payment is documented and allocated correctly.

Example: Record $500 as a prepayment from Customer A for a $1,500 project.

2. Generate the Invoice

Create an invoice for the total amount due for the goods or services provided. Clearly mention the total value of the transaction, including any prepayment received.

Example: Invoice Customer A for $1,500, noting the $500 prepayment.

3. Apply the Prepayment to the Invoice

Deduct the prepayment amount from the invoice’s total. This step ensures the remaining balance due is accurate and transparent.

Example: Apply the $500 prepayment to the $1,500 invoice, leaving a balance of $1,000.

4. Communicate with the Customer

Send the updated invoice to the customer, ensuring they understand how the prepayment has been applied and the outstanding balance.

Best Practice: Include a detailed breakdown of the payment application.

5. Update Your Records

Reflect the prepayment application in your financial records. This ensures your accounts receivable, revenue, and customer accounts are accurate.

Tip: Use accounting software to automate this process and reduce errors.

Best Practices for Applying Prepayments

Use Clear Documentation: Always provide detailed receipts and invoices that specify the prepayment amount and how it’s applied.

Communicate Terms Upfront: Clearly outline your prepayment policies in contracts or agreements to avoid misunderstandings.

Track Prepayments Separately: Maintain a separate ledger or account for prepayments to ensure they are easily traceable and correctly allocated.

Leverage Technology: Invest in accounting software that supports prepayment tracking and application to simplify the process.

Monitor Compliance: Ensure your prepayment practices comply with local tax regulations and accounting standards.

Common Challenges and Solutions

1. Misallocation of Prepayments

Challenge: Prepayments may be applied to the wrong invoice, causing discrepancies.

Solution: Use customer-specific identifiers and detailed records to ensure accuracy.

2. Customer Disputes

Challenge: Customers may question the prepayment application.

Solution: Provide detailed explanations and clear documentation to resolve issues.

3. Accounting Errors

Challenge: Manual processes can lead to errors in recording or applying prepayments.

Solution: Automate the process using reliable accounting software.

FAQs

Why should I use a liability account for advance payments?

Advance payments are considered liabilities until the goods or services are provided. Recording them in a liability account ensures compliance with accounting principles and provides accurate financial reporting.

Can I use QuickBooks to track multiple advance payments for the same customer?

Yes, you can track multiple advance payments by linking each to its respective invoice or by maintaining detailed notes in the Memo section.

What if the advance payment exceeds the invoice amount?

Any excess can remain as a credit on the customer’s account and applied to future invoices.

How do I refund an unused advance payment?

In QuickBooks Online, use the Refund Receipt feature. In QuickBooks Desktop, go to Customers > Create Credit Memos/Refunds and process the refund.

How do I ensure my tax reports are accurate?

Ensure that advance payments are not reported as income until the related goods or services are delivered. Properly link payments to invoices to maintain accurate tax records.

Conclusion

Recording advance payments correctly is essential for maintaining accurate financial records and complying with accounting standards. QuickBooks Online and Desktop offer straightforward processes to manage these transactions. By setting up a liability account, properly recording the payment, and linking it to invoices, you can ensure your books are both accurate and compliant. If you’re ever in doubt, consult with an accounting professional for guidance tailored to your business needs.