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Advance Payment

A payment made for a good or service before it is delivered

What is Advance Payment?

Advance payment is a payment made for a good or service before it is delivered. It can be required from the buyer to ensure a down payment on said good or service or to pay for the cost of production.

 

Advance Payment

 

The balance of the payment can be required in installments as a continued part of an advanced payment structure or delivered at the end upon delivery of the good or service. The capital provided as a part of an advanced payment can be a critical part of the funding structure of a business, especially in acquiring expensive machinery or logistics.

 

Advanced Payments in Big Businesses

Companies that manufacture large, expensive pieces of machinery – such as fighter planes or commercial airliners – often require advance payments as part of the payment structure for delivery. There are many reasons that it is in their best interest to do so. The first primarily being that it shows a commitment from the buyer that they are invested in the delivery of the product. It is a significant gesture, especially if the payment is non-refundable and substantial.

The second reason is that it provides capital to fund costly projects. In the aircraft example above, it can provide the necessary capital needed to construct something that may end up costing hundreds of millions of dollars. It will help aircraft manufacturers to avoid going to a bank or financial institution for money.

Criticisms exist of some large businesses that employ such a type of payment method. When companies ask for advance payments from ordinary consumers, it can be like a company requesting an interest-free loan en masse. However, it is also an effective way of promoting product scarcity, and it is an effective marketing tool.

 

Advanced Payments in a Startup

One of the critical components of getting a start-up off the ground is capital raising and funding. Often, entrepreneurs lack the existing capital required to fund and grow their business themselves. Online platforms, such as Kickstarter, are one way for budding entrepreneurs to get access to funding to build their product and take it to market.

With such a type of capital raising, interested contributors make advanced payments for products they wish to see the company produce. They do it to get contributor bonuses or to be among the first to receive the product. Such types of advanced payments are completed as a unique way of bringing products to market that may otherwise never get launched.

 

Risks with Advanced Payments: Getting Your Money Back

One potential disadvantage that exists when utilizing the advanced payment method as a consumer is that you may encounter difficulties in reclaiming your capital should the company you’re investing in go bankrupt. Without a strong contract in place that can protect your payment, you may find yourself in a drawn-out legal battle to reclaim your payment.

The above highlights the critical reason for fully understanding the nature of an advanced payment that you are contributing towards. In doing so, you will understand the opportunity costs of doing it.

Platforms like Kickstarter often employ a threshold barrier that capital raisers must obtain to be allowed to collect the money they’ve raised. It can provide peace of mind and an effective way for contributors to get their money back if other consumers do not share their optimism for a product or service, and it becomes no longer financially viable.

 

Summary

Advanced payments are generally payments made for a good or service before it is delivered – paid either in a lump sum or installments. They are completed as a way of capital raising and help provide the necessary funds for companies to build expensive products.

Advanced payments are a way for consumers to demonstrate their commitment to buying a product that takes many months or years to complete – like an airplane. Strong contracts help mitigate some of the risks in providing advanced payments as a consumer.

Also, advanced payments can be an effective marketing tool by promoting scarcity and creating marketing buzz around an upcoming product.

Platforms like Kickstarter provide an innovative way for entrepreneurs to raise money through the advanced payment method to help develop their products.

 

Related Readings

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Prepayment
  • Installment Loan
  • Mortgage Servicing Rights (MSR)
  • Startup Valuation Metrics

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