A recording contract is an agreement between the record label and the artist. It is always an exclusive agreement. Signing the contract commits you to making a certain amount of recordings within a specific amount of time. It also prohibits you from recording for any other record labels.
One of the primary parts of a recording contract concerns the royalties that a band or artist earns for their music. In signing the contract, a band or artist agrees to make recordings or albums in exchange for a certain percentage of record and CD sales. Major labels often agree to as much as 10 or 15 percent. The royalty agreement also covers the "deductions," or items that factor into the royalty payment to the artists. For example, no royalties are paid for promotional CDs, and if a "packaging deduction" is in the contract, it makes the artist responsible for defraying the costs incurred by the label for manufacturing CDs. If the royalty rate is 12 percent and the packaging deduction is 25 percent of that, your royalty rate is actually 9 percent.
An advance is the amount of money given up front to the band or artist when the contract signed, usually as an advance against expected royalties. The amount of the advance depends on both the artist and the record label. Major record labels are in a position to offer more substantial advances than independent or smaller labels. There is not a universal formula for deciding on an advance. The costs for recording a professional album have a large number of variables, such as the size of the band, the music genre, the recording studio and engineers, the professionalism, and the work habits of the band, and all of those will bear on determinations of an advance.
An advance is best thought of as a loan to the band or artist. A record label signs an band or artist because the label sees the potential for making money. The advance is an investment that the record label is willing to make to cover all the costs for recording and promoting an album. The record label advances money up front for a variety of purposes, such as studio time and recording costs, promotion and advertising, and live performances and touring. If the record label advances a band $200,000, the band must pay the $200,000 back out of royalties before they begin receiving royalty payments. If the album doesn't sell well, the band is obligated to pay the money out of their own pockets.