How do I record income from clients who pay in advance for future work?

Understanding the situation: you’ve been paid, but the work isn’t done yet

When a client pays you before you deliver the work—whether that’s a deposit, a retainer, a prepaid package, or full payment up front—you’re holding money that is connected to a future obligation. That single idea is the key to recording advance payments correctly: the cash has arrived, but you haven’t earned it yet.

Many people who run small businesses, consultancies, agencies, or freelance practices feel an understandable pull to record the payment as income the moment it lands in the bank. It feels like income. It improves cash flow. You can see it in your account. But accounting is less about feelings and more about timing and evidence: revenue is generally recognized when it’s earned, not when it’s received, unless you’re using a method that records income on a cash basis.

So the real question becomes: which accounting method are you using, and what does that method require you to do with money received in advance?

Two common accounting methods: cash basis vs accrual basis

How you record advance payments depends heavily on whether your books are kept on a cash basis or an accrual basis. Both approaches are widely used. Many small businesses start on cash basis because it’s simpler, while larger organizations or those with more complex operations often use accrual because it provides a clearer view of performance over time.

Cash basis: income when cash is received

Under cash-basis accounting, you typically record income when you receive money and record expenses when you pay them. In its simplest form, if a client pays you £2,000 today for work you’ll do next month, cash basis would treat that £2,000 as income today.

This is one reason cash basis can feel straightforward: your “income” lines up with your bank deposits. However, it can distort your real performance during periods where prepayments are common. A busy month of collecting retainers can look wildly profitable even if the work hasn’t started, while the next month can look slow or unprofitable even though you’re delivering on prior prepayments.

If you’re using cash basis for tax purposes or internal reporting, make sure you still track your delivery obligations so you don’t accidentally overbook yourself or misunderstand how much of your bank balance is truly “free” to spend.

Accrual basis: income when it’s earned

Under accrual accounting, you record revenue when you earn it—usually when you deliver the service or the product, or when you meet the performance obligations you promised. If you receive cash in advance, it is not immediately recognized as revenue. Instead, you record it as a liability, often called “unearned revenue,” “deferred revenue,” “client deposits,” or “payments received in advance.”

This approach gives you a more accurate picture of your business because it matches revenue to the period when the work is actually performed. It can also reduce the temptation to spend money that you still “owe” to the client in the form of future service.

Key terms you’ll see in bookkeeping for advance payments

Different industries use slightly different language, but the underlying mechanics are the same. Here are the most common terms and what they mean in plain English.

Unearned revenue (deferred revenue)

This is money you’ve received but not yet earned. It is recorded as a liability because you owe the client work (or a deliverable) in the future. As you complete the work, you move amounts from unearned revenue into revenue.

Client deposits

Deposits are often partial payments upfront. A deposit can be refundable or non-refundable, depending on your contract and local rules, but from a bookkeeping perspective it’s still commonly treated as unearned revenue until you deliver the related service.

Retainers

Retainers can be structured in multiple ways. Some retainers are advance payments for a defined set of services (for example, “10 hours per month” or “monthly SEO management”). Others are more like a fee to reserve availability, sometimes called a “true retainer.” How you record a retainer depends on what the client is actually paying for: future services, ongoing access, or reserved capacity.

Revenue recognition

Revenue recognition refers to the rules and practices that determine when you record revenue. If you’re running a small business, you don’t need to become an accountant to do this well, but you do need a consistent policy that matches what you promised the client and what you deliver over time.

How to record advance payments under accrual accounting: the basic journal entries

The simplest way to understand accrual accounting for advance payments is to follow the money through two stages: (1) when the payment is received and (2) when the work is performed.

Stage 1: When the client pays in advance

When you receive the money, you increase cash (an asset) and increase unearned revenue (a liability). You are acknowledging: “We have the cash, and we have an obligation.”

In journal entry form, it typically looks like this:

Debit: Cash / Bank

Credit: Unearned Revenue (or Client Deposits / Deferred Revenue)

Stage 2: When you deliver the work (earning the revenue)

As you complete the work, you reduce the liability and recognize revenue. You are essentially transferring the amount from “we owe work” to “we earned it.”

Typical journal entry:

Debit: Unearned Revenue

Credit: Revenue (Sales / Service Income)

Why this matters: clarity, compliance, and decision-making

Recording advance payments correctly isn’t only about “doing the books properly.” It protects you in at least three practical ways.

First, it gives you a clearer view of your real profitability. If you treat all prepayments as income immediately, you can end up believing you’re doing better than you are, especially in businesses with long delivery cycles.

Second, it improves cash management. If you separate “earned” from “unearned,” you’re less likely to spend money that is already committed to future costs (like contractor time, materials, or your own labor).

Third, it helps you stay aligned with tax and reporting requirements. Even if you’re on cash basis for tax, you may still need a sensible internal view of what revenue you have actually earned within a period.

Practical examples: deposits, retainers, and prepaid packages

Let’s look at common real-world scenarios and how the recording works.

Example 1: A client pays a 40% deposit for a project

Imagine you quote £5,000 for a project and the client pays a £2,000 deposit to secure the start date. You receive the deposit today, and you’ll deliver the project next month.

Accrual basis at time of receipt:

Debit: Bank £2,000

Credit: Client Deposits (Unearned Revenue) £2,000

Then, as you deliver the project next month, you recognize revenue. If you invoice the remaining £3,000 later, that’s separate. The deposit portion becomes revenue when you start meeting the project obligations—often when milestones are completed, deliverables are delivered, or the project is completed, depending on how you define “earned.”

When the project is completed and you can consider the deposit earned:

Debit: Client Deposits £2,000

Credit: Project Revenue £2,000

Example 2: A client prepays for 10 sessions of coaching

Suppose a client pays £1,000 upfront for 10 coaching sessions. You deliver one session each week.

At payment receipt:

Debit: Bank £1,000

Credit: Unearned Revenue £1,000

Each week, after a session is delivered, you recognize one-tenth of the revenue (assuming each session is equal value):

Debit: Unearned Revenue £100

Credit: Coaching Revenue £100

This method gives you an accurate monthly revenue figure and also shows, at any time, how many sessions you still owe.

Example 3: A monthly retainer for ongoing services

Many service businesses charge a monthly retainer paid at the start of the month. If the retainer is payment for that month’s services, then it becomes earned as the month progresses (or when the month’s services are delivered).

If the client pays £2,000 on the 1st of the month for that month’s work, you might record it as unearned on day 1, then recognize revenue throughout the month. Some businesses recognize it daily; many recognize it monthly at month-end for simplicity.

At receipt (1st of month):

Debit: Bank £2,000

Credit: Deferred Revenue £2,000

At month-end (if the month’s services are fully delivered):

Debit: Deferred Revenue £2,000

Credit: Retainer Revenue £2,000

Choosing a recognition pattern: point-in-time vs over-time

When you move money from unearned revenue to revenue, you need to decide what “earned” means for your services. The best method is the one that matches your actual delivery and your promise to the client.

Point-in-time recognition

This approach recognizes revenue when a specific deliverable is handed over or a milestone is completed. It works well for discrete items like “deliver a logo package” or “publish a website.” If the contract is clearly satisfied at a defined point, recognizing at that point is often sensible.

Over-time recognition

This approach recognizes revenue gradually as the service is performed. It’s common for ongoing services like management retainers, support contracts, or subscriptions. If you provide value continuously over a period, recognizing revenue over time can better reflect reality.

Milestone-based recognition

Many project-based businesses use milestones, especially when payments are tied to phases. If a client prepays or partially prepays, you can recognize the prepayment as each milestone is completed, transferring proportional amounts out of deferred revenue.

How to handle VAT or sales tax on advance payments

Taxes on sales can complicate prepayments because tax timing rules do not always match revenue recognition. Depending on your jurisdiction and scheme, you may be required to account for VAT or sales tax at the time you receive payment, at the time you issue an invoice, or at the time you deliver goods or services.

From a bookkeeping standpoint, you may need to split an advance payment into a net amount and a tax component. The tax component is typically a liability to the tax authority, not income.

For example, if you receive £1,200 and £200 of that is VAT, you would generally record:

Debit: Bank £1,200

Credit: VAT Payable £200

Credit: Deferred Revenue £1,000

Then, as you earn the revenue, you move the £1,000 from deferred revenue into revenue. The VAT payable remains a tax liability until you remit it according to your filing.

Because VAT rules can be strict and vary by region, it’s worth aligning your invoicing, payment receipt process, and your VAT scheme so you don’t end up with unpleasant surprises at filing time.

Refunds, cancellations, and contract changes

Advance payments often come with questions like: “What if the client cancels?” or “What if scope changes?” Good bookkeeping follows the contract, and good contracts make the bookkeeping easier.

If the advance payment is refundable

If a deposit or prepayment is refundable under certain conditions, it remains a liability until the conditions for keeping it are met. If the client cancels and you refund them, the accounting is straightforward: you reverse the liability and reduce cash.

Refund entry:

Debit: Deferred Revenue (or Client Deposits)

Credit: Bank

If part of the payment becomes non-refundable after a certain point

Some agreements state that a deposit becomes non-refundable after a kickoff call, after reserving capacity, or after a certain date. When the non-refundable condition is met, you may recognize that portion as revenue (assuming it represents earned consideration, such as the service of reserving time or administrative work already done).

The important thing is that the recognition is tied to something you actually did or provided, not merely to the passage of time unless the contract is explicitly a “standby” or “availability” arrangement.

If scope changes mid-project

If a project expands and the client pays additional money in advance, treat the additional payment the same way: record it as deferred revenue at receipt and recognize it as you perform the additional work. If scope decreases and you issue a partial refund, reduce deferred revenue accordingly (or reduce revenue if the work had already been recognized).

How to set up your chart of accounts for advance payments

To keep things tidy, it helps to create a dedicated liability account. Many accounting systems include this by default, but you can also tailor it to your business.

A simple and effective structure

Here’s a common setup that works for many small businesses:

Liabilities:

• Deferred Revenue (or Unearned Revenue)

• Client Deposits (optional separate account)

• VAT / Sales Tax Payable (if applicable)

Income:

• Service Revenue (or separate lines like Consulting Revenue, Design Revenue, Coaching Revenue)

This separation ensures you can quickly see how much money you’ve collected that is still tied to future obligations.

How to record advance payments in common workflows

Even if you understand the theory, the day-to-day bookkeeping can still get messy if your process isn’t consistent. The best workflow depends on how you invoice, how you collect payment, and how you deliver work.

Workflow 1: Invoice first, then receive payment

If you issue an invoice that clearly states it is an advance payment, many accounting systems will post the invoice to accounts receivable and then clear it when payment arrives. Under accrual, you may still want the system to classify that invoice amount to deferred revenue rather than revenue.

This often means using a specific “product/service item” or “income category” mapped to deferred revenue, or using a liability item designed for deposits. Then, when you deliver the work, you create a second transaction—often a sales receipt, invoice, or journal entry—that moves the amount from deferred revenue to revenue.

Workflow 2: Receive payment first (before issuing the invoice)

Some businesses receive a bank transfer or card payment before issuing any invoice. In that case, record the receipt directly to deferred revenue (and VAT payable if relevant). Then issue the invoice later, applying the payment to it. The key is to avoid accidentally classifying the initial receipt as income.

Workflow 3: Subscription or automated recurring billing

For subscriptions or monthly retainers charged automatically, you’ll want a consistent policy: recognize revenue as the period passes and you provide the service. Some systems automate this with “deferred revenue schedules.” If you don’t have that feature, you can still do it manually at month-end by moving a monthly amount from deferred to revenue.

Reconciling your bank when you use deferred revenue

Bank reconciliation can feel confusing the first time you start separating cash from income. You might see £10,000 deposited in the bank, but only £4,000 recognized as revenue for the month. That’s not an error; it’s the point.

Your bank balance is about cash. Your profit and loss statement is about earned performance. Deferred revenue is the bridge between those two views. When reconciled correctly, your cash can be high while revenue is moderate, because you’re holding prepayments you haven’t earned yet.

What to do if you’ve already recorded advance payments as income

It’s common to realize, after months or even years, that you’ve been recording prepayments as income immediately even though you intended to use accrual-style reporting. The fix depends on your goals and whether you’re preparing financial statements, managing taxes, or simply trying to clean up internal reporting.

From an internal bookkeeping perspective, you can reclassify a portion of income into deferred revenue based on work not yet delivered. This typically involves a journal entry that reduces revenue and increases deferred revenue.

For example, if you discover that £3,000 of December “income” was actually for work to be delivered in January and February, you could post an adjusting entry:

Debit: Revenue £3,000

Credit: Deferred Revenue £3,000

Then, as you deliver the work, you recognize it properly. If taxes are involved, it becomes more sensitive because adjustments may affect filings. In those cases, it’s wise to coordinate the correction with a qualified professional so you don’t accidentally create inconsistent records.

How to decide what portion is earned at any given date

If you’re delivering work over time, you’ll need a consistent method for measuring progress. It doesn’t have to be perfect, but it should be reasonable, repeatable, and tied to how you deliver value.

Common approaches for service businesses

• Time-based: Recognize revenue based on hours delivered compared to hours promised.

• Milestone-based: Recognize revenue when defined project milestones are completed.

• Straight-line: Recognize evenly over the contract period (often used for retainers and subscriptions).

• Output-based: Recognize based on units delivered (sessions completed, reports delivered, pages completed, etc.).

Pick the approach that best matches how the client experiences value and how you manage the work internally. If your contract is “10 sessions,” an output-based approach is intuitive. If your contract is “ongoing management for a month,” straight-line or month-end recognition is usually fine. If your project has clear phases, milestone-based is often best.

Retainers: the “true retainer” vs “advance for services” distinction

Retainers deserve special attention because people use the word to mean different things.

An “advance for services” retainer is essentially a prepayment. The client is paying for work you will do. In that case, deferred revenue is usually the correct treatment under accrual, and you recognize revenue as you perform the work.

A “true retainer,” in some professional contexts, is a fee paid to secure availability or priority access, regardless of whether services are actually used. If your contract explicitly states that the retainer is earned upon receipt because it is payment for reserving capacity, you may recognize it sooner. However, you should be careful: calling something “non-refundable” doesn’t automatically make it earned from an accounting perspective. The key is whether you have provided the service that the retainer represents (for example, being on standby and forgoing other work).

In practice, most small businesses offering monthly retainers are delivering ongoing services, not purely selling availability. That makes a deferred-then-earned-over-time approach the most straightforward and defensible.

Prepaid expenses vs advance income: don’t mix them up

Advance income (deferred revenue) is a liability because you owe the customer something. Prepaid expenses are assets because you’ve paid someone else for something you’ll receive later—like insurance paid annually upfront or a software subscription paid for the year.

They can look similar because both involve timing differences, but they sit on opposite sides of the balance sheet. Keeping them distinct helps avoid confusion when you review financial statements.

How advance payments affect your financial statements

Understanding the statement impact helps you explain your numbers to yourself, your partners, or an accountant.

Balance sheet impact

When you receive cash in advance, assets (cash) increase and liabilities (deferred revenue) increase. Your equity does not change at that moment because you have not earned anything yet; you’ve simply taken on an obligation.

Profit and loss impact

Your profit and loss statement changes only when you recognize revenue. That recognition is the moment your business is treated as having “earned” the income for that period.

Cash flow statement impact

Advance payments often show up as positive operating cash flow even if they do not increase profit immediately under accrual. This is one reason service businesses can feel cash-rich while profitability looks moderate: clients are funding future delivery.

Common pitfalls and how to avoid them

Advance payments are simple conceptually, but a few common mistakes can create messy books.

Pitfall 1: Recording prepayments as revenue and forgetting the obligation

If you record everything as revenue on receipt, you may lose track of what you owe. A simple fix is to maintain a separate schedule—like a spreadsheet or project tracker—that shows prepayments, delivery status, and remaining balance of unearned revenue per client.

Pitfall 2: Mixing VAT/sales tax with revenue

Sales taxes collected are not your income. Make sure your bookkeeping splits tax into a payable account and keeps revenue net of tax where appropriate.

Pitfall 3: Not having a consistent policy for partial completion

Decide whether you recognize revenue at milestones, at completion, or over time. Then apply that consistently. Inconsistent recognition makes monthly comparisons meaningless and can lead to disputes if internal numbers don’t match your operational reality.

Pitfall 4: Forgetting to recognize revenue at month-end

Deferred revenue only works if you regularly move earned portions into revenue. If you never do the second step, your revenue will be understated and deferred revenue will be overstated. A recurring month-end checklist item can prevent this.

Pitfall 5: Treating all retainers the same

One client’s retainer might be a prepaid package, while another’s might be a fee for access. Your contract language and actual delivery should drive the accounting.

Setting up a simple month-end routine

If you want clean records without overcomplicating life, create a month-end routine that takes 20–60 minutes depending on volume.

1) Review your list of clients with deferred revenue balances.

2) For each client, determine what portion of the prepaid work was delivered during the month.

3) Post the revenue recognition entry (debit deferred revenue, credit revenue) for the earned amount.

4) Confirm that your deferred revenue balance roughly matches your outstanding work obligations.

5) If you collect VAT/sales tax, ensure the tax liability aligns with invoices and receipts for the period.

This routine can be as formal or as lightweight as you need, but the habit is what keeps deferred revenue accurate.

What your contract should clarify to make accounting easier

Your bookkeeping gets dramatically easier when your client agreements are clear about what the upfront payment represents and when it becomes earned.

Helpful contract details include:

• Whether the upfront payment is a deposit, prepaid service, or availability fee

• Whether any portion is refundable, and under what conditions

• How services are delivered (sessions, milestones, monthly deliverables)

• How unused time or scope changes are handled

• Payment schedule and invoicing timing

When these are explicit, you can map your revenue recognition to the contract without guessing.

How to explain advance payments to clients (and to yourself)

Clients sometimes ask why their invoice says “deposit” or why you’re providing receipts that mention “payment in advance.” A simple explanation builds trust: “This payment reserves your start date and covers work to be delivered in future stages.”

Internally, the same clarity matters. If you’re looking at a large bank balance, it’s easy to think, “We can invest, hire, or spend this.” But if a big chunk is deferred revenue, a more accurate statement is: “We are holding funds for work already sold but not yet delivered.” That perspective leads to smarter decisions and fewer stressful delivery crunches.

Quick decision guide: how should you record it?

If you want a fast way to decide, use these questions:

• Do you use cash basis accounting for your books and reporting? If yes, you will usually record income when money is received, while still tracking what you owe operationally.

• Do you use accrual basis accounting for your books and reporting? If yes, record the payment as deferred revenue when received, then recognize revenue as you deliver.

• Is VAT/sales tax included? If yes, split the tax portion into a tax payable account rather than income.

• Is the payment tied to a specific deliverable, sessions, or a time period? If yes, match recognition to the deliverable/sessions/time period.

Final thoughts: treat advance payments as a promise

Advance payments are a sign that clients trust you and that your offer is valuable enough to pay for before it’s delivered. But that trust is also a responsibility. Recording prepayments accurately—especially under accrual accounting—keeps that responsibility visible in your financial statements.

The most important habit is separating “cash received” from “revenue earned.” When you do that consistently, your books become a reliable tool rather than a confusing collection of deposits and invoices. You’ll know what you truly earned this month, how much work you owe, and how much of your cash is already spoken for. That clarity makes planning easier, pricing decisions smarter, and growth more sustainable.