Module I· Working Capital & NWCIntermediate
Question
How do you handle customer advances / prepayments?
Answer
Mechanics
advances are a cash inflow without revenue recognition — typical in machinery, plant engineering, and made-to-order manufacturing.
Booking on receipt of an advance
| Account | Δ |
|---|---|
| Cash | +X |
| Customer advances received (liability) | +X |
Under IFRS 15 this liability item is a 'contract liability' (similar to deferred revenue, but for long-term projects). On project acceptance or at a milestone, the advance becomes revenue and the liability unwinds.
Deep diveShow more details
NWC modeling
- Advances are NOT netted against AR — they are a separate liability.
- Δ advances affects OCF like Δ deferred revenue: a build-up brings cash, a drawdown consumes cash.
- With strongly fluctuating advance volumes (project business), the year-end snapshot is especially distorting.
Example — machinery
machinery and capital-equipment makers show advance-payment ratios of 10–25% of order intake. On a $500m plant, typically $50–125m of cash flows in before the project starts.
Pitch tip
for project-business targets, model the advances cycle separately in the DCF — 'reported NWC' is not representative; 'NWC excl. customer advances' plus a separate project-funding logic is cleaner.