Money upfront or annually over 5 years?

Question

Lets say I am running a business. I have a client who I will provide a service for five years. What is better, to receive one bill for the five years of service for $1,000,000 or to receive a $200,000 annually for the duration of five years (under a contract)?

Answer 1

One thing to consider is your accounting method....cash or accrual.

If your business uses the CASH method, you must recognize the cash in the year it is received (or in the year it is paid assuming you are paying the money). In this case, regardless if you are the payer or payee, you may want the payments to be made in even installments over the 5 years. To get that much money in a single year will create one hell of a tax bill, whereas over many years, it will be partially offset by business expenses. Conversely, to pay that much in one year will cause a huge defecit which is also not ideal for many reasons that I won't go into detail here.

If your business uses the ACCRUAL method, the income/expense is recognized in the year the service is provided regardless when it is paid. That means if your are the payer, you will claim $200,000 per year in expenses and if you are the payee, you will claim $200,000 per year in income regardless when the money changes hands. In this case, if you are the payer, you want to delay payment as long as possible. Conversely, if you are the payee, you want that money as soon as you can get it.

If your business is new, you can choose whichever method you want. Keep in mind, all expenses are "expensed" in the year they are used, not necessarily in the year they are paid when using the accural method, so it can be a bit more of an accounting headache. For example, if you buy lumber to build a barn in December and use only 10% of it by the end of the year, you can only write off 10% of the cost of the lumber that year even though you already paid for the whole boatload.

You can always make a request to the IRS to change your accounting method. Refer to Publication 538 on www.irs.gov for more details.

One last thing, if your business is large enough (annual gross income of more than $1 million) or a "tax shelter", you must use the accrual method.

Answer 2

If the cost is the same, I'd just receive the bill @ once. Typically there will be an incentive for doing it one way or the other. In the situation mentioned, it would be better to make the payment for the entire time frame @ once, that way if the price of the service rises within the 5 years, the client is obligated to provide the service at the $20,000 a year rate.

Answer 3

Interesting. Either way you accept it, from an accounting purpose, you have to recognize the revenue over the life of the service contract. The benfit of taking money upfront is that you have the float and so there is the issue of time value of money provided you can really generate a decent rate of return on it. At a minimum you can get a CD at 5%. Cheers

Answer 4

Take the money up front. The value of money decreases over time.

Just be sure to keep enough to cover that contract for the 5 years that you are expected to honor the contract.

Answer 5

if you have a client, aren't you the one providing the service?

I cant think of a business where clients pay to provide services

Answer 6

Ask a financial advisor. The yellow pages are full of 'em or google some in your area

Answer 7

Would be better for you to have the money up front. But then again, you may want to adjust your price each year for inflation. Just my guess.