How to Record Advance Payments and Customer Prepayments in QuickBooks?

An advance payment (prepayment) in QuickBooks is money you receive before delivering a product or service, and you must record it as a liability, not income, until you complete the work. Many users record it incorrectly, which leads to issues like overstated revenue, inaccurate reports, and mismatched customer balances. In QuickBooks, there is no single “error code” for advance payment issues, but users commonly encounter system prompts or inconsistencies such as;

“This transaction is linked to another transaction.”

“You must specify an account for this transaction.”

“Prepayments do not correctly apply to invoices.”

In this guide, you will quickly understand what advance payments are and why businesses use them. Then, you will learn step-by-step methods to record prepayments in QuickBooks Online and Desktop. Finally, you will see how to manage, edit, refund, and track prepayments to keep your records accurate.

What is an Advance Payment (Prepayment) in QuickBooks?

An advance payment, also known as a prepayment, refers to a transaction where a customer pays for a product or service before it is delivered or completed. In business accounting, this type of payment can take different forms, such as a deposit, a full upfront payment, or partial payments made at different stages of a project based on its progress.

In QuickBooks, advance payments are not treated as immediate income. Instead, they are recorded as a liability (often called unearned revenue) because the business still owes goods or services to the customer. Once the product is delivered or the service is completed, the amount is then moved from the liability account to income.

In simple terms, advance payments help businesses reduce financial risk by ensuring they receive funds upfront. This improves cash flow and provides the working capital needed to manage operations, purchase materials, or cover project costs before fulfilling the customer’s order.

Common Reasons for Requiring Prepayments

Businesses require prepayments for a variety of financial, operational, and risk-management reasons, especially when dealing with high-value transactions or project-based work, including:

• Acting as security or insurance for large orders
• Covering upfront expenses and material costs for projects
• Reducing the risk of non-payment after delivery
• Ensuring customer commitment before starting work
• Allowing customers to include transactions in the same financial year for tax purposes
• Enabling pre-booking or reservation of goods and services
• Improving cash flow and working capital availability
• Minimizing payment delays and collection efforts

Advantages and Disadvantages of Advance Payments

Advance payments can be beneficial for businesses, but they also come with certain limitations. Understanding both the advantages and disadvantages helps in deciding when and how to implement this payment method effectively.

Advantages of Advance Payments

• Reduced risk of financial loss due to upfront payment
• Better alignment of revenue and expenses within the same tax period
• Less need for follow-ups and collection efforts
• Improved and consistent cash flow management
• Simplified process for generating and managing invoices

Disadvantages of Advance Payments

• Lack of trust from new customers, leading to hesitation in paying upfront
• Changes in project scope may require adjustments and additional invoices
• Refund processes can be complex and time-consuming

How to Record Customer Prepayments in QuickBooks Online?

Recording customer prepayments in QuickBooks Online involves setting up the correct accounts and following a structured workflow to ensure accurate financial tracking and reporting.

Step 1: Setting up a Liability Account

This step ensures that advance payments are recorded as liabilities instead of income until the service or product is delivered.

• Go to Settings (Gear Icon) > Chart of Accounts
• Click on New to create a new account
• Choose Other Current Liabilities as the account type
• Select an appropriate detail type (e.g., Trust Liability Account)
• Enter a name like Customer Prepayments
• Click Save and Close

Step 2: Creating a Product/Service Item for Prepayments

This step links your transactions to the liability account so that prepayments are tracked correctly.

• Go to Sales > Products and Services
• Click New and select Service
• Enter a suitable name (e.g., Advance Payment)
• In the ‘Income account’ field, select the liability account created for tracking prepayments.
• Save the item for future use

Step 3: Recording the Prepayment via Sales Receipt

This step records the actual advance payment received from the customer.

• Click on + New > Sales Receipt
• Choose the Customer name
• Select the Product/Service created for prepayments
• Enter the amount received
• Choose the payment method and deposit account
• Click Save and Close

Step 4: Creating an Invoice for the Final Sale

This step helps track the actual sale once the product is delivered or the service is completed.

• Click on + New > Invoice
• Select the customer
• Add the actual products/services delivered
• Enter the correct amount and details
• Save the invoice for further processing

Step 5: Applying the Prepayment Credit to an Invoice

This step ensures that the advance payment is adjusted against the final invoice.

• Open the invoice created
• Select Receive Payment
• Choose the customer and locate the open invoice
• Apply the available credit (prepayment)
• Confirm the applied amount and save the transaction

How to Record Advance Payments in QuickBooks Desktop?

In QuickBooks Desktop, recording advance payments involves a slightly different workflow compared to QuickBooks Online. Depending on the business scenario, you can use multiple methods to track customer and vendor prepayments effectively on your QuickBooks Desktop (Pro, Premier, and older Enterprise versions).

Option 1: Using Estimates and Sales Orders

This method helps businesses track advance payments against ongoing jobs or orders before final invoicing.

Step 1. Create a Current Liability Account

• Go to Lists > Chart of Accounts
• Click New > Other Account Types > Current Liability
• Enter the account name and save

Step 2. Create a Service Item Linked to the Liability Account

• Go to Lists > Item List > New
• Select Service
• Link it to the liability account created

Step 3. Record Sales Receipts for advance payments

• Go to Customers > Enter Sales Receipts
• Select customer, payment date, and deposit account
• Choose the prepayment service item
• Enter the amount and save

Step 4. Create an Invoice to track the final transaction

• Go to Customers > Create Invoices
• Add product/service details
• Add a prepayment item as a negative line

Step 5. Receive any remaining balance payment

• Open invoice > Click Receive Payments
• Enter the balance amount and save

Option 2: Recording Prepayments as Customer Credits

This method records advance payments as credits that can later be applied to invoices.

Step 1. Create a liability account for prepayments

• Go to Lists > Chart of Accounts > New
• Select Current Liability and save

Step 2. Record the advance payment as a credit

• Go to Customers > Enter Sales Receipts
• Select the customer and the prepayment item
• Record the amount and save

Step 3. Create the invoice for the actual sale

• Go to Customers > Create Invoices
• Add products/services and save

Step 4. Apply the credit to the invoice

• Open invoice > Click Apply Credits
• Select available prepayment credit
• Save transaction

Option 3: Recording Advance Payments for Vendors and Suppliers

This method is used when making advance payments to suppliers or vendors, and can be handled via ‘Accounts Payable’.

Step 1. Write a check to the supplier

• Go to Banking > Write Checks
• Select the supplier and enter the amount
• Choose Accounts Payable in the account column

Step 2. Enter the bill

• Go to Vendors > Enter Bills
• Fill details and save

Step 3. Apply the advance payment to the bill

• Go to Vendors > Pay Bills
• Select bill > Click Set Credits
• Apply advance and save

Managing and Tracking Prepayments

Properly managing and tracking prepayments in QuickBooks is essential to maintain accurate financial records, ensure correct revenue recognition, and avoid discrepancies in customer or vendor balances.

How to Modify or Edit an Advance Payment

Editing an advance payment allows you to correct errors or update transaction details without affecting overall accounting accuracy.

• Go to Sales > Customers (or Customers menu in Desktop)
• Locate and open the Sales Receipt or Payment transaction
• Make the necessary changes (amount, date, account, or customer details)
• Ensure the correct liability account is still selected
• Click Save and Close to update the transaction

Giving a Refund: How to Give Back a Prepayment

If a customer cancels an order or overpays, you may need to refund the advance payment properly.

• Go to + New > Refund Receipt (QuickBooks Online) or Customers > Create Credit Memos/Refunds (Desktop)
• Select the customer name
• Choose the prepayment or liability account
• Enter the refund amount and payment method
• Select the appropriate bank account for the refund
• Click Save and Close

Running Reports to Track Open Prepayments and Sales Orders

Running reports helps monitor unused prepayments, outstanding balances, and linked transactions.

• Go to the Reports menu
• Search for reports like:
  • Customer Balance Detail
  • Transaction List by Customer
  • Sales by Customer Detail
• Filter reports to identify open credits or unapplied payments
• Customize date range and account filters for better tracking
• Review linked transactions to ensure proper application of prepayments

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