Recognized & deferred revenue
Last updated
Last updated
Revenue should be recognized at the time the service or goods are delivered. Deferred revenue can be used to account for payments received before delivery. This is especially relevant for SaaS companies selling annual subscriptions. Here, we walk through how to set it up in Francis.
Accounting theory stipulates that revenue should be recognized when the service or goods are delivered. This approach ensures revenue is recorded when it is earned rather than when it is invoiced or paid. The objective is to create a representative view of the company’s activities and income.
Deferred revenue, also known as unearned revenue, helps keep track of payments received in advance of delivery. It represents amounts invoiced to customers for goods or services to be provided in the future and is recorded as a liability on the balance sheet. Once the service is performed or the product is delivered, deferred revenue is moved to the income statement as recognized revenue.
Generally, there are four critical points in the revenue cycle:
Booked: An order is placed, or a contract is signed. No financial entries are recorded at this stage, but it is essential for sales forecasting and compensation planning.
Invoiced: The company invoices the customer for goods or services.
If invoicing occurs before delivery, this creates deferred revenue.
If payment is due after invoicing (e.g., on 45-day payment terms), it creates accounts receivable.
Recognized: Revenue is recognized when the company fulfills its performance obligations by delivering goods or services. At this point, it is recorded on the income statement.
Paid: The company receives payment from the customer. This impacts cash flow but does not directly affect revenue recognition.
Recognized and deferred revenue pertain to points “2. Invoiced” and “3. Recognized.” To account for “4. Paid” in your forecasts, you should include receivables to reflect varying payment terms.
A running club sells annual memberships, including three March, May, and August events.
Initial Payment: Members pay the annual fee upfront in January.
Deferred Revenue Recording: The entire payment is recorded as deferred revenue.
Revenue Recognition: As each event occurs, the club recognizes one-third of the annual fee as revenue, aligning income recognition with service delivery.
A SaaS company charges customers upfront for a 12-month subscription.
Initial Payment: Customers pay the full annual subscription fee at the start.
Deferred Revenue Recording: The balance sheet records the total amount as deferred revenue.
Revenue Recognition: Each month, the company recognizes one-twelfth of the annual fee as revenue corresponding to the services rendered that month.
To estimate recognized revenue for a given month, you need to know (1) the length of the service period (in months) and (2) the invoiced amounts from the preceding months covering the full service period.
This approach lets you recognize revenue proportionally each month by allocating the invoiced amount evenly across the service period.
Here is an example with new invoice amounts each month. This can represent new or existing customers being billed for a new service period.
Notice that all recognized and deferred revenue calculations are based on invoiced amounts. You only need to forecast invoiced amounts, which flow through your model.
To forecast recognized revenue for a 12-month subscription, you’ll need 12 months of historical invoicing data. We recommend importing this data via our Google Sheets integration, though manual input is also an option.
Depending on your needs, you can forecast at either the customer or product level. Customer-level forecasting can provide valuable detail if you have a few large customers, while product-level forecasting may offer a more manageable overview for businesses with many smaller customers.
Suppose you sell products with different service periods, such as 12-month and 24-month subscriptions. In that case, it’s best to separate them into individual forecasts and independently estimate the invoiced amounts for each product and period.
A frequent question is: How does deferred revenue impact cash flow?
The short answer is that deferred revenue is an accounting measure that accurately represents revenue over time and does not directly impact cash flow. For example, if a customer pays an invoice of $2,400 upfront, the cash received is $2,400 regardless of when the revenue is recognized.
However, deferred revenue does appear on the cash flow statement:
Recognized revenue flows to the cash flow statement through the net profit line.
Changes in deferred revenue are reflected in the cash flow statement under “changes in deferred revenue.”
The net effect on cash flow, though, corresponds to the actual payment received from the invoice, not the timing of revenue recognition.
If invoices have payment terms that delay cash flow, this is managed through accounts receivable.
Some companies already use Excel models or other tools to forecast recognized and deferred revenue and may prefer to keep this model outside of Francis. In that case, you can create your forecasts externally and easily import the results into Francis.
This approach allows you to leverage Francis’ version control, variance analysis, and reporting features while maintaining the underlying modeling elsewhere. Simply copy and paste two metrics into Francis: recognized revenue and deferred revenue.
