The advance to suppliers refers to the payment that is made in whole or in part to a seller of products, before they have been satisfactorily received by the purchasing company. It is also known as prepayment term or prepaid purchase.
When a company agrees to buy from a supplier, the supplier is expected to have adequate working capital or resources to provide the necessary goods or services.
Paying in advance to a supplier incurs additional costs for the company, as well as introducing the risk of losing advanced features in the event of the supplier’s bankruptcy, thus reducing the company’s ability to negotiate in the event of a dispute.
Prepayments can help suppliers who don’t have enough cash flow to buy the materials that fill a large order so they can use some of that money to pay for the product they will make.
It can also be used as an initial guarantee to start manufacturing a product that can be customized or unique.
Features of advance payment to suppliers
Companies need to make advances to suppliers when their orders are large enough to become a burden on the producer.
Companies must have a policy on advances, including the business process such as breaking the purchase order, sending the invoice, accounting reconciliation, handling sales tax, and receiving.
– Purchase Order
The total purchase order amount must include the down payment amount and a full description of the refund policy offered by the supplier.
In the case of advances, the supplier, when accepting the order, will consider the contract accepted, admitting to execute it in accordance with the terms and conditions of the order.
Suppliers who are issued a full advance payment must provide a final or pro forma invoice for the full amount of the advance before payment is issued. The invoice must contain ratification of the total cost, including taxes, shipping, handling, etc.
It is not recommended that suppliers submit a pro forma invoice as an estimate and then invoice the full actual amount. This subsequent invoice must be considered a duplicate and no further payment must be made to the supplier.
Suppliers who are issued a partial advance payment are responsible for providing a final or pro forma invoice for the same amount as the piecemeal portion of the order, including the prorated amount of taxes and freight/freight, before issuing the partial advance.
– Protection against risks
If the supplier declares insolvency, the buyer’s rights will conflict with those of the seller’s other creditors. A few points should be considered when making a down payment to the supplier to protect yourself from potential risks and dangers.
The supplier’s reputation should be a deciding factor in whether or not to prepare for early delivery. It’s best to do a little research and find out how they fared on other projects. There’s no point in giving money to the highest bidder if you’ve never been able to complete a project.
Review a best offer
The seller in question may have provided the best price. However, you should check for another provider whose price may be a little higher but does not require the risk of receiving an advance payment. This must be carefully considered, in addition to reasoning for the risk implications.
It must be ensured that the provider has the necessary experience to complete the work for the indicated price, before handing over any amount of money. For example, make sure you have qualified personnel for this.
Is it active or passive?
Advances are payments made in advance, such as advances for a contractual project or service. They are already paid, although they have not yet been incurred. They will be recognized as an asset or as an expense until the project or service is completed.
These are considered assets and have a normal debit balance, which will increase when debited and decrease when credited. The following example can be taken:
In step number 1, company XYZ paid a 50% advance for the improvement of their offices, which has a total cost of $500,000. For the payment made, the Advance account to suppliers is debited to increase it and the Cash account is credited.
In the next step, XYZ company made full payment when the provider’s work was completed. Now, the accounting record will be the debit to the corresponding fixed asset account, which is Office improvement.
In addition, the Advances to Suppliers account is closed by crediting it and the cash payment is recorded for the remaining balance, crediting it to the Cash account.
This Advances to Suppliers account will appear on the balance sheet in the Current Assets section.
The reason it is an asset account is because it constitutes the right to receive a certain product or service. On the other hand, in case the purchase is not made at the end, it represents the right to be able to receive the money back.
Examples of advance supplier payments
Monthly rent payments
These lease payments are generally required at the beginning of the lease term.
Annual maintenance payments
Maintenance of scientific or medical equipment, office equipment or software/hardware maintenance, computer service contracts such as Internet access, systems and databases, or software licenses.
In such cases, full annual payment is usually expected at the beginning of the contract term.
Payments of interinstitutional agreements
A company may make advances in interinstitutional agreements, provided that the paying agency documents the circumstances of the need.
Payments for professionals
Advance payments for court-appointed artists, speakers, expert witnesses or mediators. In such cases, it may be necessary to advance a portion of the fee before the contract date.
advances in advertising
In some cases, it may be necessary to advance part or all of the payment when placing an ad.
Advances on insurance premiums
These payments to the corresponding insurers are usually required at the beginning of the coverage period.
Prepayments for chartered trips
It may be necessary to advance part or all of the payment when hiring the bus, plane or other chartered transport.