Vendor Advances: The Procurement Money That Leaves Before Anything Arrives

Most owner-managed businesses watch their payables closely. Very few watch the money that goes out before anything comes in.

Pull your trial balance and look for "advances to suppliers" or "capital advances". In a business doing Rs 300 to 500 crore of turnover, that figure is frequently Rs 5 to 15 crore. Now ask the harder question: how much of it sits against a purchase order nobody has chased for eighteen months?

In most companies nobody can answer that in a single afternoon. That inability is itself the finding.

Why vendor advances accumulate

An advance usually starts as a commercial necessity. A new supplier wants comfort. A custom-fabricated machine needs 30 per cent with the order. None of that is wrong.

The problem is what happens afterwards. Finance releases the advance against a purchase order, but recovery sits with the buyer, who has moved to the next order. No single person owns the balance. It ages quietly in a ledger reviewed once a year, by which time a vendor confirmation letter closes the matter.

Three patterns recur:

• Advances paid against purchase orders later cancelled or reduced in quantity, with no refund ever demanded

• Advances adjusted against a different invoice from the same vendor, breaking the trail back to the original order

• Advances to vendors who have stopped supplying altogether, still carried at full value because nobody has tested recoverability

The vendor advances report to ask for

Ask for a vendor advance ageing, not a vendor advance balance. They are different documents and only one is useful. It should show, for every open advance: vendor name, purchase order reference, date paid, amount, quantity received against that order to date, and the unadjusted balance.

Then apply three tests:

• Any advance older than 180 days with nil receipt against the order. Ask the buyer, in writing, what the recovery plan is and by when.

• Any vendor where cumulative advances exceed the purchase order value. This should be arithmetically impossible and usually means a payment was made outside the purchase order workflow.

• Any advance to a vendor with no transaction in the last twelve months. That is a recovery case, not a procurement balance.

You will usually find a handful of vendors account for most of the aged balance, and that at least one has some connection to someone inside the business.

The governance and tax tail

Where an advance is in substance an interest-free funding line rather than a genuine procurement payment, it takes on the character of an advance in the nature of a loan. Under CARO 2020, the statutory auditor reports on the terms of such advances, amounts overdue beyond ninety days and whether reasonable steps have been taken for recovery, with specific disclosure where promoters, directors, key managerial personnel or related parties are involved. An aged advance to a connected supplier is precisely what surfaces there.

On GST, an advance paid for goods earns you no input tax credit. Section 16(2) of the CGST Act allows credit only once you hold the invoice and have received the goods or services. Notification 66/2017-Central Tax removed the requirement for suppliers to pay GST on advances received against goods, so in most goods purchases there is no tax document at the advance stage at all. The money is out; the credit is not.

On presentation, advances paid towards plant, machinery or property are capital advances, and under Schedule III they belong in other non-current assets, not in capital work-in-progress. Getting this wrong quietly overstates the asset base a lender or investor is looking at.

The bottom line

• Vendor advances are unsecured lending to your suppliers. Apply the same discipline you apply to receivables.

• Fix ownership. The buyer who negotiated the advance owns its recovery until the goods land, and it belongs in that buyer's monthly review.

• Cap the exposure by policy: a percentage ceiling of order value, a higher approval level above it, and a stated recovery period.

• Review the ageing quarterly, not annually. A twelve-month-old advance is usually a negotiation. A thirty-month-old advance is usually a loss that has not been recognised.

The number itself is rarely the story. The absence of anyone who can explain the number is.

By CA Dhruv Seth, Seth & Associates, Chartered Accountants, Lucknow

This article is for general information and does not constitute audit, legal or tax advice. Regulations change; please verify the current position or speak to a qualified adviser before acting.