What is the Difference Between Annuity and Ordinary Annuity?

utah778/iStock/GettyImages

You might not be familiar with this specific use of the term, but your business deals in annuities if you make or receive regular, recurring payments at set intervals. Those payments may mark either the beginning or the end of a time period, which has accounting and planning implications.

Examples of Annuities

In the business context, an annuity is any payment made or received at set intervals. The word itself derives from the Latin for "year," but any payment interval – quarterly, monthly, even weekly or daily – is considered an annuity in this sense as long as it recurs regularly. The familiar retirement annuities offered by insurance companies fit that description because funds are paid out at specified intervals. If you bill your customers on a monthly cycle, that's also an annuity in this sense. So are the monthly or quarterly lease payments you make on vehicles or pieces of heavy equipment.

Different Types of Annuity

Although any payment scheduled at regular intervals is an annuity, there are differences between them. One of the most fundamental differences concerns when the payments are made. If the payment comes at the end of the term, that's referred to as an ordinary annuity. If you own your building, for example, the mortgage payment is an ordinary annuity because it pays for the month that has just ended. The opposite term is annuity due, which means the payment for the service comes first followed by the use of the service or product. Payments to your cellular carrier for the company's phones fall into this category.

Why the Difference Matters

There's a reason the difference is significant. A fundamental principle of accounting and economics is the notion of "time value of money," which simply means that a dollar today is worth more than a dollar tomorrow. Today's dollars can be put to use and earn money, while tomorrow's dollars can and will be eroded by inflation. The longer the term and the larger the amounts involved, the more important this distinction becomes. It won't necessarily mean much to a startup with 100 customers, but it counts a great deal for a wireless carrier with tens of millions of subscribers.

Applying the Principle

The difference between annuity due and ordinary annuity underlines what business owners already know: It's best to have the money in your own hands for as long as possible. In practical terms, that means billing on an annuity due basis whenever possible and paying on an ordinary annuity basis. That won't always be under your control. Some industries default to one or the other, and swimming upstream might not be an option, but it's something to strive for whenever you can set or negotiate the terms.

References

About the Author

Fred Decker learned business fundamentals at second hand as an insurance and mutual funds broker, and at firsthand as a retail store manager and the chef/proprietor of his own restaurants. He has written hundreds of business-related articles for sites including Zacks.com, Chron.com, Vitamix.com, Bizfluent and GoBankingRates and many others. He was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.