Formally, a lump sum is a financial transaction in which money is transferred in a single payment rather than 2 or more. The money (or any other form of consideration) must be exchanged for a specific product or service. It is a key concept in consumer finance.
Lump sum is similar to but not the same as one-time payments, which is a term used to differentiate single transactions from recurring payments in the context of subscription businesses.
Summary
In most cases the purchased product is delivered at the time of the money transfer, but simultaneous delivery is not necessary for a lump sum payment to occur. Goods can be provided before or after payment, and they can be provided in multiple deliveries.
The most common scenario for lump sum payments is payouts from pension plans, but the reality is than most daily consumer transactions are lump sum because they are small price tags, and multiple payments does not make much sense.
Lump sum payments are least common for goods with a medium price tag (appliances, furniture, ). They're also uncommon for services, where a portion of compensation is withheld until completion.
Finally, the use of debt financing has a specific impact on lump sums. Because loans are typically used for high price tag goods, there is a lump sum payment from the bank to the seller, then multiple payments over time from the buyer to the bank.
Meaning
In simple terms, a lump sum is a payment made all at once instead of 2 or more times. It can occur in virtually any transaction.
For example, paying cash at the grocery store is a lump-sum payment, and a business that purchases bulk of stock in a single transaction is also a lump sum payment.
However, the term is most commonly used in cases where the payee has a choice between lump sum payment and the alternative — multiple transactions.
How it Works
A lump sum payment works by transferring the full amount of a payment in one transaction, regardless of medium (card, wire, check, or other). The only requirement is that the transaction be singular.
The product can be delivered before or after payment, and it can be delivered all at once or in multiple instances. The following three headings explore this constraint and delivery flexibility.
#1 Single Product or Service
One condition of lump sum payments is that it applies to a single product or service and not a single provider. For example, a customer at Home Depot may make a lump sum payment for a Drill but make multiple payments on a larger item such as a lawn mower.
In other words, he makes multiple payments to one business and only one of them is a lump-sum.
#2 Asynchronous Delivery Allowed
The single product or service does not, however, need to be delivered at the time of the lump sum payment. Products delivered before or after payment are common in business-to-business environments.
For example, consider a coffee shop that purchases coffee beans from a local distributor.
They submit a bulk order for 100 bags that get delivered before payment so the shop can perform quality assurance. Alternatively, the coffee shop purchases table napkins whose payment must be made before delivery.
In either case, the product can arrive before or after the lump sum payment is made.
#3 Multiple Deliveries Allowed
In addition to asynchronous delivery, the product of a lump sum payment can be delivered over multiple days, months, or years.
This is notably the case with insurance. For example, consider consumer travel insurance. One payment at the beginning of a 1-month period is a lump sum, but the coverage extends to each of the 30 days.
Another example is bulk packages delivered over time. Using the example of the coffee shop, the bean bags may be delivered in two batches over two weeks due to their weight. The lump sum payment can still occur after the second delivery.
Lump Sum vs. Annuity
In the classic pension example, annuities are the opposite of lump sum payments. Pension beneficiaries have the option of taking their benefit in one lump sum payment, or in a separate payout each year until death called an annuity.
Other Examples
Lump sum payments exist in virtually every context money is found, but the following four examples provide rich context to explore some nuances.
#1 Lottery
Winners of the lottery face a similar situation as pension investors. Winnings can be paid in a lump sum or in separate payments each year until the full winnings are recovered.
The difference is that lottery managers usually reduce the size of the pot for lump sum payments to encourage the annuity structure (annuities are better for lotteries because it allows them to hold money for investing, lending, and other activities).
This is an instance where the term "lump sum" is used intentionally to denote the choice the recipient makes due to real, consequential differences between lump sums and the alternative — in this case annuities.
#2 Bullet & Balloon Payments
Bullet and balloon payments are synonyms that refer to a single payment used at the end of a closed-end loan. In most instances, these are not lump-sum payments because they are one payment among previous installments.
However, in some cases an installment loan is actually paid in one-shot. This can happen when borrowers only need money for a short time but use an installment loan for a large amount of principal.
They use a bullet/balloon payment to payoff the loan early, usually just accepting early repayment penalties. By deduction, the need to manage cash reserves with the loan is worth the penalties in these instances.
#3 Credit Cards
Credit cards present two opportunities for lump sum payments. Every purchase on a credit card is a lump-sum. However, card balance payments can be lump sum OR multiple.
For example, consider a cardholder who purchases a $1,000 television on her card. If she pays the balance in at the end of the month, then (you guessed it) this is a lump sum. However, if she carries some of the balance into the next month for a later payment, then it's not a lump sum.
#4 Buy Now Pay Later
Buy Now Pay Later (BNPL) is not necessarily lump sum. If the service is provided by a third party other than the buyer and seller, there is a lump sum payment from the third party to the seller and non-lump payments from the buyer to the third party.
However, if the BNPL service is provided by the seller, then there is no lump sum because the terms of payment are — by agreement — made in multiple instances.
Pros & Cons
All other variables controlled, lump sum payments are better for the receiver and worse for the payer. This is due to the time value of money.
The payer forfeits her money up front and therefore cannot use it elsewhere, whereas the receiver obtains the funds for immediate use rather than waiting for each installment to come through.
The ability to use money now rather than later means holders can get a return on the funds by investing in risk free bonds — or any other investment of their choosing.
It's just a good principle of money management: never pay now what you can pay later without interest.
