Finance Insights for Entrepreneurs: Revenue Recognition
By Cross Atlantic Business Advisors, LLC
Prior to hiring your first CFO, you may hire a bookkeeper or less experienced accountant. In this series, we discuss issues entrepreneurs should be aware of until they have a CFO. These are important issues that could minimize your company’s value in the eyes of investors.
First let’s talk about revenue recognition. In a retail environment, revenue recognition is easy. When a person buys a suit at a department store that department store records a sale immediately. However, in other industries, it’s less simple. Although it may seem reasonable, a signed contract does not mean revenue should be recorded immediately.
There are four technical conditions that need to be met for revenue to be recognized. (Since you are likely NOT sitting for the CPA exam soon, we won’t list each, but would be happy to explain in more detail if you email us here). A contract is the only the first step. One key question you need to ask: have we delivered the service or product to the customer (i.e. do we have some billings that have not been earned)?
For example, if you sell security software as a service to the financial industry and banks pay you $12,000 for the year, that revenue needs to be recorded over the year as $1,000 per month.
Another example may be contract terms in which there are milestones involved. For example, 50% of the contract may be due upon signing and the rest will be due in several months. While you bill the 50% immediately, all of that is most likely NOT revenue.
So, what do you do if you’re an entrepreneur with little to no accounting experience and have contracts like the ones described? Make sure you ask your accountant or bookkeeper how they are recording revenue to ensure that you don’t recognize revenue too quickly. This accountant or bookkeeper should have some portion of those billings in Deferred or Unearned Revenue.
Today we covered recognizing revenue too quickly. Next time, we cover recognizing revenue too slowly. Sign up here to receive the next Insight in this series.
Cross Atlantic Business Advisors, LLC, is an international consulting firm providing finance and marketing services to small and mid-sized businesses around the world. Follow us @CAbizAdvisors or www.crossatlanticadvisors.com