Why are customer deposits necessary?
According to Level, 9 out of 10 contracting businesses fail within ten years. One of the primary reasons is poor payment schedules set in contracts which can force companies into financing project costs out of their own pocket.
One way to overcome this cash flow issue is to ask your customers for an upfront deposit before the job starts. However, QuickBooks Online is not set up by default to deal with these types of customer deposits. If you’re capturing deposits as a negative Accounts Receivable amount, you risk understating your liabilities on your Balance Sheet, which can lead to severe interpretation problems! Here’s why and how to fix it.
The difficulty of recording customer deposits
A business doesn't own a customer deposit until a specific “event” happens, typically when the service starts or when the first invoice is issued. For example, if the business had to default on the service or go bankrupt prior to the “event” happening, it would be required to pay customer deposits back to its clients. Hence, customer deposits are a liability until the “event” happens. Recording customer deposits as a negative Accounts Receivable would understate the business’s liabilities. This could ultimately lead to serious interpretation risks and cash flow problems, like business owners financing tax payments and shareholders loans through customer deposits, without being aware of what they are doing.
How to record customer deposit the right way
Best practice for bookkeeping/accounting for customer deposits is to treat customer deposits as a liability until it's not. Doing so will give you the comfort of knowing you are not using funds that don’t belong to you (yet) and ensure you won’t be left with nasty cash flow surprises in the future.
As mentioned above, QuickBooks Online is not set up by default to handle customer deposits properly. In this video, construction management expert Leeroy from Level shares a quick walkthrough of how to set up your QuickBooks Online to capture and manage customer deposits based on best bookkeeping practices.