What is a prepayment?

Definition

A prepayment is cash sent to a vendor before the goods or services arrive. On the books it is an asset, not an expense yet, because you still have a claim on the vendor until the delivery happens.

Where it shows up

Balance Sheet: Located in the current assets section, as a prepaid until the goods arrive.

P&L: Related to nothing extra until the prepaid is later used.

Cash flow: Related to cash leaving before the expense is earned.

See also: Prepaid Expenses · Vendor Bill · Accounts Payable

When you look at the Balance Sheet, the amount sits in the current assets section. It stays there as a prepaid until the bread, the software period, or the rent month is used.

The P&L does not move at the moment you wire the money. Expense appears later, when the prepaid is used up, and that later step belongs on another page.

On the Statement of Cash Flows, cash has already left as an operating out. That cash out is earlier than the expense, which is the whole point of this term.

A large prepaid is cash that is no longer in the bank. A small one is usually a deposit on a single order, and both still sit as assets until they are used.

How it works

You agree to pay before delivery. The purchase order may call for a deposit, or the vendor may require cash in full before they will ship.

You send the money. Cash goes down, and prepaid expenses go up by the same amount.

No open payable has to exist yet. Accounts payable is for goods already received and not yet paid, which is the opposite timing from a prepayment.

If a vendor bill arrives with the order, you do not treat the prepayment as a second bill. You keep the prepaid on the books until the goods are there to use.

A check run can include prepayments alongside ordinary vendor payments. The difference is there is no payable balance to clear; you are creating an asset instead.

When you look at the bank statement, the wire is just another cash out. The books have to remember it is a prepaid, not an expense, so a bank reconciliation that only ties cash will not tell you whether the asset is still valid.

The support behind the entry is the purchase order, the vendor's deposit request, and the payment confirmation. Those documents stay with the prepaid until the balance is used or refunded.

Until the goods arrive, cash stays down and the asset stays up. If the vendor never delivers, the prepaid is a claim you have to collect, not an expense you already earned.

Example

A neighborhood cafe wires the bakery $800 for next month's bread before any loaves arrive. The prepayment, not the later delivery, is recorded as:

Debit: Prepaid expenses $800

Credit: Cash $800

Cash is down $800. Prepaid expenses, a current asset, is up $800, and the P&L does not move.

Common mix-ups

A prepayment is not a duplicate payment. A duplicate is paying a bill you already paid, while a prepayment is paying before the goods are even due.

A prepayment is not accounts payable. Payables are what you owe after you already received the goods, and a prepayment is cash you already sent.

A prepayment is not the later expense. The expense waits until the goods are used, and the prepayment is the asset that sits until then.

Related terms

• Prepaid Expenses: Amounts paid up front for goods or services the business has not yet used.
• Vendor Bill: The invoice a supplier sends that becomes a payable.
• Accounts Payable: Amounts the business owes vendors for goods or services already received.
• Purchase Order: The document authorizing a purchase from a vendor at agreed terms.
• Vendor Statement Reconciliation: Comparing a supplier's statement of your account to your own payable records.
• Deferral: Pushing recognition of a cost or revenue to a later period than the cash movement.
• Account Reconciliation: Proving that a ledger balance agrees to independent support.
• Cash Flow Forecast: A forward projection of cash receipts and payments.