Advances and down payments: how to record them correctly

VAT on an advance payment: due immediately

The main rule: you owe the VAT in the period in which you issue the invoice for the advance, or in which you receive the prepayment if that is earlier. Not only when the job is done. If you receive a down payment in March for a project delivered in June, the VAT on that down payment belongs in the return for the first or second quarter, depending on your filing period, but certainly not only in July.

So send a proper invoice with VAT for every advance, with its own invoice number and a description of what the down payment covers. A payment request without an invoice is hard for your client to process and gives you no clean basis in your records.

The final invoice: offset the advance visibly

On the final invoice you state the total amount of the assignment, and below it you deduct the previously invoiced advances, including the VAT already charged on them, referencing the invoice numbers. What remains is the amount still payable and the VAT still due. This way, each invoice shows exactly the VAT belonging to that period, and the total across all invoices adds up to the full assignment.

Revenue and profit: when does it count?

For determining your profit, things differ from VAT. An advance received for work still to be performed is not yet profit in accounting terms: it sits on your balance sheet as deferred revenue until you deliver. For a small sole proprietorship this often makes little difference within the same financial year, but if a project crosses the year boundary, the distinction does matter for your annual figures. Your bookkeeper processes this via work in progress or deferred revenue.

If the project falls through

If an assignment is cancelled after you have invoiced an advance, the settlement depends on what you agree. If you refund the advance, you send a credit invoice and recover the remitted VAT through your return. If you keep (part of) the advance as a cancellation fee, record what it covers: a fee for work already performed remains taxable revenue. Clear cancellation terms in your quote prevent discussion afterwards.