For many small businesses and start-ups, revenue reporting rules may seem daunting. Fortunately, technological advances have streamlined revenue reporting by automating manual processes and enhancing financial visibility, allowing you to get the best view of when revenue should be recognised and when the cash will arrive.
What is revenue recognition?
Investors and accountants periodically refer to correct revenue recognition. What does this mean, and why does it matter?
Revenue recognition simply means that revenue is shown in the P&L when it is earned, rather than when it is received or when it is invoiced.
Businesses across various industries accept upfront payments for goods or services, which can be helpful to boost cash flows and pay operating expenses. However, this prepayment is treated as unearned revenue until the goods or services have been provided.
Examples of deferred revenue include:
- Retainers received by lawyers or accountants
- Deferred income for rent or insurance
- Subscriptions and memberships
What is the difference between deferred revenue and accrued revenue?
Deferred revenue, also known as unearned revenue, is revenue invoiced but where you haven’t yet delivered the goods or services. Deferred revenue is recognised as a liability until the goods or services have been delivered.
In contrast, accrued revenue is where you provide the goods or service and then invoice. Accrued revenue is recorded as an asset in your balance sheet, signifying that the customer owes money to your business.
Why does revenue recognition matter?
This may all seem like accounting jargon, so why does it matter to you?…For two simple but significant reasons.
First, investors and banks expect revenue to be shown when the service is delivered. All companies looking for funding – either debt or equity – need to insure that they show revenue in the month the service is delivered.
Early stage venture capitalists tell us that half of the companies that seek investment do not follow this principle. Without understanding your revenue, investors frequently just give a polite no, meaning your company could be missing out on well deserved investment for this simple reason.
Second, and perhaps more importantly, showing revenue as it is earned provides the clearest view of the business. Correct revenue recognition is critical to sing your active customers, understanding those at risk of churning and monitoring who is buying more (or less) over time.
Nearly half of surveyed leaders stated that without clear revenue processes, they are less able to strategise, forecast, and budget. Reporting income when it’s earned is essential for financial and directional planning purposes and to spot trends early.
How do accountants recognise revenue by month?
The accounting process to show revenue in the correct month is laborious.
Here is an example of the accounting entires for an annual upfront payment of $12,000:
01 Feb 2021
The below journal entry is later recorded to recognise the first month of subscription revenue:
01 Mar 2021
As adjustments are required each month to recognise revenue as it’s earned, manual processes can be time-consuming and prone to data entry errors. A simple annual invoice will require at least 13 accounting entries as well as spreadsheet tracking.
An easier way to accurately manage revenue recognition each month is to automate deferred revenue spreading with adaptive software such as ScaleXP.
Why ScaleXP is the best solution for accrued and unearned revenue
ScaleXP fully automates deferred and accrued revenue recognition.
The system will automatically scan invoices issued in your accounting system – Xero, Quickbooks, Sage, NetSuite. It will allocate revenue to the correct month based on text in the invoice itself. As a simple example, the system will split an ‘annual’ invoice over 12 months.
The system is fully compliant with IFRS and GAAP accounting standards. This gives you peace of mind by knowing you can substantiate reported revenue figures. The system ensures that your financial data can be easily shared with investors or your bank, helping you access capital whenever it may be required.
The system is easy to setup. Most companies onboard in less than 1 hour, saving time each month by avoiding manual data entry for revenue spreading.
Learn more about how ScaleXP can help you save time, improve efficiency, clarify financial reporting, and enhance investment opportunities.
We connect to Xero, QuickBooks, Sage, NetSuite and many more to automate accrued & unearned revenue.