Many businesses use prepayment to manage cash flow and expenses. Paying up-front can change how a business shares risk, how cash moves through a business, and how revenue and expenses are tracked over time. It also changes how businesses operate and plan for expenses.

Below, we explain what prepayment is, how it works, and what it means for businesses balancing cash flow and growth.

What’s in this article?

• What is prepayment?
  
• How does prepayment work in business?
  
• What are the benefits and risks of prepayment?
  
• When are prepayments typically used or required?
  
• How does prepayment affect cash flow and accounting?
  
• How is prepayment different from deposits, retainers, or advance payments?
  
• How Stripe Payments can help
  

What is prepayment?

Prepayment means paying before you’re contractually required to. In business, it means money changes hands before a product is delivered, a service is performed, or a scheduled payment date arrives. It is sometimes also referred to as an advance payment.

In terms of accounts receivable, prepayments are commonly used in service sectors where the product cannot be easily resold and where production costs are high. In terms of accounts payable, prepayment is often used to make sure expenses are recorded in a specific quarter or other time frame.

In financing agreements, prepayment means paying down principal ahead of schedule. This reduces interest but can incur penalties, depending on loan terms.

How does prepayment work in business?

Business agreements, contracts, and loans should define how prepayments are used and under what terms.

Here’s how prepayment works:

• Contracts or invoices specify how much is to be prepaid, what it covers, and when any remaining balance is due. Loan terms specify how much can be prepaid without penalties.

• Some contracts require a percentage up-front, others require full payment before work begins. Prepayments are often tied to milestones in longer projects. Prepayments on loans are usually up to the borrower.

• Even though money moves early, accrual accounting requires revenue or expenses to be recognized only when the service is performed or the product delivered. Until then, prepaid amounts are tracked separately.

• The contract should state what happens if obligations aren’t met: prepaid funds might be refunded, forfeited, or applied differently.

What are the benefits and risks of prepayment?

Prepayment reshapes cash flow, risk, and responsibility for both parties to a transaction.

Here are the benefits and risks of using prepayments.

Benefits of collecting prepayments

• Greater payment certainty: Receiving funds up-front eliminates the risk of late or missed payments.

• Stronger short-term cash flow: Prepayment brings cash in earlier, which can support payroll, inventory purchases, or project startup costs.

• Lower administrative burden: When payment happens before delivery, there’s less need for invoicing, reminders, or collections.

• Clearer customer commitment: The up-front payment reduces cancellations or scope changes once work is underway.

Risks of collecting prepayments

• Higher delivery obligation: Taking payment early raises the stakes for the business delivering the product or service. Failure to perform can result in refunds, disputes, or reputational damage.

• Cash management discipline required: Businesses need to manage prepaid funds carefully so money collected early is still available when delivery costs arise.

• Potential customer resistance: Some customers are uncomfortable paying ahead, especially in new relationships. Strict prepayment terms can slow sales or push buyers toward more flexible alternatives.

• Prepayment penalties: For loans, making prepayments can save on interest but can incur prepayment penalties.

When are prepayments typically used or required?

Prepayment tends to be used when timing, risk, or up-front cost make pay-later terms impractical for a business.

Here are some common circumstances:

• Custom or made-to-order work: Businesses often require prepayment to cover materials and labor when goods or services can’t be easily resold. This is common in manufacturing, construction, and professional services.

• Projects with high up-front costs: If a business needs to spend money early on inventory, equipment, or staffing, prepayment helps fund that work directly. It reduces the need to front costs or rely on short-term financing.

• Events and time-limited services: Event venues, caterers, and production teams frequently require deposits or full prepayment to reserve dates and resources.

• New or higher-risk customers: Prepayment is often used when there’s no payment history or elevated credit risk. It shifts exposure away from the seller until trust is established.

• Subscription-based models: Many subscriptions are prepaid by design. Customers pay in advance monthly, quarterly, or annually for access.

• Discounted pricing: Some businesses offer better pricing or added benefits in exchange for advance payment. Prepayment becomes part of a value trade rather than a risk-control mechanism.

Businesses with high-interest loans often try to make prepayments when they can to minimize how much interest they accrue over time.

How does prepayment affect cash flow and accounting?

Prepayment affects when cash moves and when revenue or expenses are recognized under accrual accounting. Businesses using cash-based accounting record prepayments immediately.

Here’s how prepayment affects cash flow under accrual accounting:

• Revenue follows delivery: Prepaid amounts are recorded as deferred revenue until goods or services are delivered. Revenue is recognized only as value is provided.

• Prepaid expenses follow delivery: When a business pays early for future goods or services, the payment is recorded as a prepaid expense and expensed over time as the benefit is received.

• Balance sheets reflect obligation: Prepayments increase cash and deferred revenue at the same time, reflecting an obligation to deliver. The presence of cash doesn’t mean it’s available for unrestricted use.

• Forecasting separates cash from performance: Forecasts can be misleading if prepayments aren’t clearly segmented. Teams need to model timing accurately.

• Tracking prevents downstream risk: Without clear visibility into prepaid balances, businesses can overspend early or underfund delivery later. Regular reconciliation keeps cash flow projections linked to reality.

How is prepayment different from deposits, retainers, or advance payments?

These terms are often used interchangeably, but they carry different implications for risk and refunds.

Here’s how prepayments differ from deposits, retainers, and advance payments:

• Prepayment: Payments made before goods are delivered, typically applied directly to the total amount owed. They’re often refundable or reallocable if delivery doesn’t occur under the agreed terms.

• Deposit: An up-front payment used to secure a commitment, often with conditions attached. If the buyer cancels, the deposit could be forfeited; if the seller fails to deliver, it is usually returned.

• Retainer: A payment made to reserve availability or priority, common in professional services. Retainers are often nonrefundable because they compensate for reserved time or capacity, not a specific service.

• Advance payment: A general term for money paid before delivery that functions much like prepayment. It’s not typically intended as a penalty or security mechanism.

How Stripe Payments can help

Stripe Payments provides a unified, global payments solution that helps any business—from scaling startups to global enterprises—accept payments online, in person, and around the world.

Stripe Payments can help you:

• Optimize your checkout experience: Create a frictionless customer experience and save thousands of engineering hours with prebuilt payment UIs, access to 125+ payment methods, and Link, a wallet built by Stripe.

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Learn more about how Stripe Payments can power your online and in-person payments, or get started today.