Deferred Revenue: An Industry Best-Practice You Can’t Afford to Ignore Any Longer
I work with a lot of companies, and sooner or later the topic of deferring revenue always comes up. Some companies do it, some don’t. Those that do tend to be happy with the process and accuracy of their numbers, though occasionally there will be a company that will be unhappy with the added work of deferring revenue. The companies that don’t defer always have their reasons. A few reasons I’ve heard go something like this: “I have a lot of other things I need to do before worrying about that,” or “Nothing is going to change by deferring my revenue,” and “It doesn’t make me any money, so why go through the hassle?”
Deferring revenue for work not completed is something that every company needs to be doing. There are two main areas where revenue needs to be deferred. The first is for deposits collected on large jobs. The second is for money collected for maintenance plans where the calls have not been run. If a company isn’t properly accounting for this money, it can significantly skew their financials
Companies that aren’t deferring revenue will ultimately show inflated revenue numbers, specifically in the month of sale. Revenue should only be recognized when the company has performed the work and earned the money. Up until that point, those funds should be held in a liability account on the balance sheet. Another issue that arises when not deferring revenue is that total revenue and expenses won’t match. If revenue is recognized when the money is received and work is performed in a different period, they will be stating an inflated profitability in the month the revenue was recognized. At the same time, the company will be understating profitability in the month the work was completed and the expenses were recognized.
Take, for example, maintenance agreements. An HVAC company will typically run two visits per year in the spring and fall to get systems ready for summer and winter. Most of those plans are sold in the summer and winter months when the systems are replaced or repaired. If the revenue is recognized at the time of sale, the peak summer and winter months look even better. In the slower months when those calls are being run, the service department looks terrible because now there’s no revenue to offset the labor, fuel, materials, and other expenses that go along with each call.
The third issue is that it’s very tough to set an annual plan if the information isn’t accurate. If there are major swings between revenue, expenses, and profitability, it’s almost impossible to set an accurate and realistic plan. Planning for staffing is going to be particularly difficult because of the peaks and valleys each company experiences throughout the year.
The point of creating financial statements is to have accurate information that can be used to make the best possible business decisions. Without properly accounting for deferred revenue, a company won’t have the benefit of access to reliable information that can be used to make those important decisions. In most cases, setting up a process to defer revenue is simple, and the many choices in software now available to companies can be a great resource in helping get things set up. Deferring revenue is more than something you “should” be doing. It’s an industry-wide best practice that your business could be benefiting from right this second.
Publication date: 4/16/2018
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