Official Luthiers Forum!

A question for you all on kind of a financially personal level. PM me if you don't feel comfortable posting the information.
When someone sends you a down payment, what do you do with it? It's intended to buy wood, supplies, etc. But what happens if the client needs to back out. Sure I have the $500 nonrefundable clause, but if I've spent the deposit on supplies, I have to come up with the remaining out of my pocket.
I haven't had this happen yet but it's a sizable fear in the back of my mind. To the point that I keep all the deposits in a bank account "just in case".
Any tips from those of you making money at this game?

I forgot to add that Jim Olsen told me a story of how he once had a near miss on a table saw. A kick back barely missed his head. Right then and there he realized that if he were to die, his wife would be stuck with more than $100K of down payments that she would have to return.
More fuel for the "keep it in the bank until the client takes delivery" argument.

If the $500 is non refundable what is the issue? The money you have invested beyond the $500?

I think the $500 is really to "take up space" on your waiting list. This fee allows them to fill the slot and presumably someone else can't. Sure new customers can go to the back of the line, but some clearly will find someone else to build them a guitar if they feel the wait is too long.

That (to me anyway) is why a non refundable deposit is important. It keeps the client's intentions honest.

With that said though. I do slow down my build schedule if a client needs more time to come up with the $$

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Brock Poling
Columbus, Ohio
http://www.polingguitars.com

I have a DBA (doing buisness as)account that it goes in and a ledger is kept on each commission. The remainder after material costs is considered income. After I pay my quarterly taxes. I then pay myself out of the DBA account.

If a client backs out the refund is an expense on the ledger. Then that ledger is balanced and closed. But all moneys goes into my DBA (doing buisness as) account

One of the guitars I'm working on now will cost me MUCH more than $500. $500 won't even buy the back/side set, let alone all the shell, paying Paul B to do a custom inlay, etc. Obviously, if this client backs out, I'll keep more than $500 because of the custom nature of the guitar. But it's still something that keeps me up at night.

[QUOTE=Pwoolson] One of the guitars I'm working on now will cost me MUCH more than $500. $500 won't even buy the back/side set, let alone all the shell, paying Paul B to do a custom inlay, etc. Obviously, if this client backs out, I'll keep more than $500 because of the custom nature of the guitar. But it's still something that keeps me up at night. [/QUOTE]

This is the very reason I went to a percentage deposit in lue of a set dollar ammount.

Yes, the deposit was a percentage, but do you keep the whole thing?

[QUOTE=Pwoolson] One of the guitars I'm working on now will cost me MUCH more than $500. $500 won't even buy the back/side set, let alone all the shell, paying Paul B to do a custom inlay, etc. Obviously, if this client backs out, I'll keep more than $500 because of the custom nature of the guitar. But it's still something that keeps me up at night. [/QUOTE]

I only refund once I have sold the guitar. I think this is fair considering you explain this clearly up front. I think most of our clients have no illusions about our cash flow.

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Brock Poling
Columbus, Ohio
http://www.polingguitars.com

100% refundable prior to material acquisition:

60% refundable less material cost after material acquisition and prior to commencement of construction:

50% refundable less materials and in cured labor after commencement of construction:

I think Paul brought up a good point. If you were to die, it's not the customer that is backing out of the deal therefore I would think that whoever is your beneficiary would be liable to repay the deposits. Sure some customers would probably not ask for the money back due to the circumstances, but you may have some that do.

I think that just because it says "non refundable deposit" doesn't mean that a dishonest luthier can collect thousands of dollars in deposits labeled as "non refundable" and then never deliver a single guitar and legally keep all of the deposits. Something would be wrong with that picture...

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Thanks,
Blain

http://www.ullrichguitar.com

"89.67% of all statistics are made up on the spot."

Paul,
If you're that concerned, then keep the deposit in the bank until such a time as you feel comfortable about the project going through as scheduled. As Brock said, if they cancel late into the project, they should have to wait until the guitar is sold to someone else until they get the rest of their money back. Or, if you get a deposit from the new buyer, you can funnel the money to the old buyer if you choose. I recently had two commissions go south for various reasons, and I'm glad I hadn't taken the deposits yet.
What I think is a good thing is this:
1. Take a $500 non-refundable deposit to hold their place in line.
2. Require a % deposit when you begin work and need to order materials. Make sure that covers the cost of the materials. On a special order, you need to be investing their money, not yours. Once the materials for their project are purchased, there's no refund available unless you complete the guitar and get it sold.
3. Take further % deposits throughout the process. This keeps the customer active in the process, and as you receive money, make sure you're communicating to your client with pictures and words the state of the progress, so they feel that their money is working for them. Some folks don't like to do this, but it works in that it keeps you from going broke working on their guitar. Imagine working a job and going a couple months without a paycheck...

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"I want to know what kind of pickups Vince Gill uses in his Tele, because if I had those, as good of a player as I am, I'm sure I could make it sound like that.
Only badly."

[QUOTE=Hesh1956] Some states have laws where a buyer can reverse him/herself at any time for say 72 hours. I think that Michigan is 72 hours....[/QUOTE]
I think that is only true for salesmen that come to your house or call you. If the customer initiates the contact, I don't think any state requires that. I could be wrong. I know that is how it works in California.   
I had a client back out recently, his down payment was the top - sinker redwood, and B/S - Honduran Rosewood. He bought them and had them shipped to me for the down payment. He told me to keep the wood when he backed out. That was nice. I will always be uncomfortable keeping anything of value if a client backs out.
I have $250 deposit to hold their place in line, and when I start I ask for the balance of 50%. Nothing is refundable. I want them as committed as I am.

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"An adventure is only an inconvenience rightly considered. An inconvenience is an adventure wrongly considered." G. K. Chesterton.

Paul,
I had a customer cancel his order last year and he fully understood the deposit was non refundable and he was OK with that. He explained the circumstance and I was touched. I told him thgat I was moving him to the bottom of the waiting list or until his financial circumstances chaged. He was thrilled. I gained his respect and friendship and did not lose a sale in the long run.

Naturally this would have to be evaluated on a case by case basis but it demonstrates some compassion when life throws us a curve ball unexpectedly.

BTW, I do keep my deposits in a separate account like Michael does.

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tim...
http://www.mcknightguitars.com

Deposits are not your money in accounting practice. They are a loan...a liability, not an asset, and that is true until you invoice. If you want to stay squeaky clean, then invoice any part that is non-refundable and spend it as you like, but in accounting practice, it all has to balance, and money in with no invoice out is technically money you owe.   

Yeah I don't spend it till the guitar has been accepted. and I have taken one back so I was glad I still had the money!!!

The other answer to your story about Mr Olsen, is to keep good records so your survivers will know who should get what. Hey I had the same thing happen to me but I did get hit

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Tickle your guitar daily, and it'll tickle you back.

Personally I will refund all the money except $200 which is used to guarantee a spot in the build schedule. As long as no woods or supplies have been specifically acquired for that guitar I will refund the remainder of the deposit.

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Peter M.
Cornerstone Guitars
http://www.cornerstoneukes.com

[QUOTE=Rick Turner] Deposits are not your money in accounting practice. They are a loan...a liability, not an asset, and that is true until you invoice. If you want to stay squeaky clean, then invoice any part that is non-refundable and spend it as you like, but in accounting practice, it all has to balance, and money in with no invoice out is technically money you owe.   [/QUOTE]

Very good point Rick. It is true that accepting a downpayment is a liability, but technically it is "deferred revenue", (It isn't technically a "loan" since it is not to be paid back in the form of money) meaning that it implies an obligation by the builder to provide a service or product to the client, and may not be claimed as revenue until such a time as an invoice can be created for other billable work done. If a contract is signed by both parties agreeing to the non-refundable clause, then the obligation of the builder to the client ceases when the client opts out of the agreement. At that point the money becomes revenue. Timing is everything with revenue...and it can get really funky as to when it can and cannot be claimed. As Rick said...you have to keep the records squeaky clean. Consult your local David Bland if you're not sure how all this works. (This was not a paid advertisement)

The accountant is now signing off for the night... Man, I do enough of that stuff all day long, I don't need to be doing it at night too!

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"I want to know what kind of pickups Vince Gill uses in his Tele, because if I had those, as good of a player as I am, I'm sure I could make it sound like that.
Only badly."

This is a bit more complicated than I will go into here but let me give you a brief explaination...

(by the way this really isn't an accounting question but rather a legal one).

The sale of a commissioned guitar is a legal action. It is a contract by which a willing buyer agrees to perform "whatever" (in this case pay cash) in return for a willing seller to give legal title to, transfer a certain good(s) to the willing buyer in exchange.

If your contract (sales agreement) clearly states that some reasonable amount is forfitable due to cancelation by the buyer than those amounts are considered "earned income". If you receive amounts that are refundable in the event of cancellation, then these funds are NOT income until earned or some other event has taken place that makes the funds non-refundable. Is it a liability? , yes...if you were to catagorize the transaction from an accounting standpoint, it would show up on the Balance Sheet (not the income statement) as a "Customer Deposits" which would be considered either a long term or perhaps short term liability (depending on how long it is expected to be "held" before being considered earned (non-returnable)). Think of the "deposit" like putting money into a Realtor's hands to buy a home...the Realtor is required to put the "deposit" into an escrow account and keep these funds unavailable for use by the realtor, other than to apply to the purchase price at closing (at least in most states). The reason for taking the "earnest deposit" is the same we take a deposit...to show that the buyer is acting in good faith and has every intention of following thru with the purchase. Many times your good faith deposit is susceptable to forfiture if you decide not to follow thru or cannot follow thru (even if for unforseen reasons).

The accounting part is simple...the amount you accept that is non-refundable is income...the balance of any monies received...definitly belongs to the buyer and is NOT yours to spend...you have a liability to return it if you cannot perform...unless your contract reads other wise...

You also have the right to sue for breach of contract if the buyer unexpectedly pulls out of the contract and you have damages (like a custom made guitar that no else is going to want). You are also expected to try and mitigate damages and therefore sell the unwanted instrument...recovering only an loss in sale price or other damages you sustain as a result.

This as I said is really a legal question and I recommend you hire a good lawyer who specializes in contract law to look over your "build contracts" for deficiencies.

Who said my small business/musicians webinars didn't have anything to do with luthiery?

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Dave Bland

remember...

"If it doesn't play in tune...it's just pretty wood"

p.s. any d.b.a. acount or other "titled" account really doesn't mean anything. You, the luthier, still have control over it. There is no law in florida, that I know of that requires, a luthier to place such funds in an escrow account. therefore where I put the money is irrelevant. It probably would be wise from an income tax standpoint to keep the "unearned revenues" in an Escrow account (especially if dealing with large amounts) so that on Audit you could show you didn't co-mingle funds and therefore hadn'r really received "earned" income that should have been reported as sales ( therby increasing profit and tax liability).

This really is more complicated...your CPA can fully explain what is best for you...Go see him/her. Especially before you really mess things up. Most people wait until year end or next year and then say "well if only I knew...what can we do now". Answer...nothing now!

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Dave Bland

remember...

"If it doesn't play in tune...it's just pretty wood"

By the way Don is partially correct it may be a "deferred revenue". "Deferred Revenues" is an accounting term used by Accrual(vs Cash basis) type enties (for either tax or other reporting purposes). An example would be delivery of 50 guitars to a music store on consignment. You may reasonably expect so many to be sold during a given time and therefore catagorize the transfer/sale as Deferred Revenue even tho none have been technically sold.

Again this is something you should discuss with your CPA.

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Dave Bland

remember...

"If it doesn't play in tune...it's just pretty wood"

pps

It really doesn't have anything to do with when you can invoice...What? A good example is again a Realtor who sells a house in December but tells his/her broker that he/she doesn't want the check dated until Jan 1 of the next year...thereby excluding the income from this years tax bill...wrong...IRS says even tho the Realtor didn't get paid until Jan 1 the events for the income to be considered such have all taken place and the income is treated "as if" the received in the prior year.

It is NOT the actual production of the invoice that makes the transaction complete, but rather the fact that the instrument is ready for delivery. So you can't deliver the guitar on 12/31 and make the invoice out for Jan 1 and think that you are legaly deferring income recognition into the next year. On audit you will loose.

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Dave Bland

remember...

"If it doesn't play in tune...it's just pretty wood"

[QUOTE=Pwoolson] But it's still something that keeps me up at night. [/QUOTE]

Try a glass of wine a little before bedtime. Perhaps a Sonoma red from the vicinity of Healdsburg.

You're overthinking this, Paul.

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Howard Klepper
http://www.klepperguitars.com

When all else fails, clean the shop.

[QUOTE=Dave-SKG] pps

It really doesn't have anything to do with when you can invoice...What? A good example is again a Realtor who sells a house in December but tells his/her broker that he/she doesn't want the check dated until Jan 1 of the next year...thereby excluding the income from this years tax bill...wrong...IRS says even tho the Realtor didn't get paid until Jan 1 the events for the income to be considered such have all taken place and the income is treated "as if" the received in the prior year.

It is NOT the actual production of the invoice that makes the transaction complete, but rather the fact that the instrument is ready for delivery. So you can't deliver the guitar on 12/31 and make the invoice out for Jan 1 and think that you are legaly deferring income recognition into the next year. On audit you will loose.

[/QUOTE]

Unless of course your accounting system is on a cash (rather than accrual) basis.

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Brock Poling
Columbus, Ohio
http://www.polingguitars.com