BusinessMay 30, 2022

Gaining the Length and Breadth of Revenue Recognition

Revenue forms the essence of any successful business, as it is the headwater for profit generation and advanced brand presence. This is why achieving proper revenue recognition becomes crucial.

Revenue recognition can be defined as a generally accepted accounting principle that specifies the method and timing of revenue being recorded and recognized as an element in the financial reports.

Differentiating Between Cash and Revenue:

The most crucial aspect to realize here is that cash does not equate to revenue. Considering cash and revenue to be the same can be a lethal mistake for any business, irrespective of a large, public organization dealing in software or a local firm dealing in clothes and apparel.

Regardless of a customer’s money reaching your bank account, it does not count as revenue unless the product or service is delivered. The rest of the balance is accounted for as deferred revenue unless you recognize it. Customers can at any time ask for a refund if they have not yet delivered the service.

This is an acceptable difference for most companies offering retail services as the product is delivered soon after the customer pays for it. However, understanding when to record revenue for subscription-based services and different business types becomes more complex.

Understanding Revenue Recording:

If you don’t document the revenue when the cash arrives in your bank accounts, when else are you supposed to record it? Revenue recognition relies mainly on the timing and sorting of the two main occasions that drive any transaction:

  1. The Revenue-Generating Process: Delivering goods or services
  2. The Payment Reception: Obtaining payment for the stated product or service as per the drafted payment terms.

The above events are separate and independent. For instance, retail stores manage payment and product delivery at the same time. Nevertheless, for many businesses, one event often occurs preceding the other. Here are a few detailed examples illustrating different variations of revenue recognition.

Instantly after the Payment Reception:

This is the most basic instance of revenue recognition. You deliver the product or service instantly upon purchase and record the revenue at the same time. The best examples are one-time purchases, like groceries or one-time service packages.

Post the Payment Reception:

It’s also normal for firms to pause to record revenue till they deliver the product or service to the consumers. This should be typical of most subscription-based businesses. The customer pays for a fixed period while the service is delivered over that course.

When you get paid to deliver a service for a specific time period, but you receive the money instantly, that amount has to be slowly recognized as revenue. Every month you provide the service for the stipulated time indicates recognizing an equal share of that income till the service delivery period has ended.

Pre-payment Reception:

Finally, revenue can also be recorded post the product or service delivery but before the payment is received. Businesses do not have to pause till the payment is received to recognize it as revenue. This is critical in accrual accounting and typically involves service-based companies. A service delivered in January, for instance, should be identified on January financial reports, even if the customer pays for that service in March. Deploying a smart subscription billing platform for such service-oriented businesses is a great way to start recognizing revenue.

Authentic Revenue Recognition Is Crucial For Business Success:

Accurate revenue recognition in non-retail businesses is a bit complicated. The disparity among several metrics such as MRR (Monthly Recurring Revenue), ARR (Annual Recurring Revenue), cash, and revenue misleads even the most veteran minds.

Learning how and when to identify your revenue is not something you can set aside and expect the best. As a business, you need to establish your revenue recognition adequately enough to defend both your enterprise and your clients and assertively reinvest in the company’s growth.