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Managing real revenue and balancing the books in the SaaS industry is an art form in itself. One crucial aspect of this financial juggling act is understanding the term "deferred revenue."
This financial concept has a fundamental role in accurately representing a company's financial health and performance.
Thus, in this article, our goal is to investigate deferred revenue in the SaaS sector, exploring, among others, what it is, how to record it, and its significance to your financial picture.
Let's start from the beginning.
Deferred revenue represents an advance payment, a prepay, that a company receives for a product or service it has yet to deliver fully. In other words, it's the cash a company receives upfront for goods or services that will be provided in the future.
Still, deferred revenue is not counted as revenue.
This prepayment is recognized as a current liability on the company's balance sheet until the good or service is delivered. So, as an incomplete revenue recognition process under accrual accounting, this money cannot be considered a revenue stream.
The same case is with deferred expenses - prepaid expenses - since they represent payments that have already been made but have not yet been incurred.
Revenue is the revenue. What's all the fuss about?
Well, deferred revenue is sometimes called unearned revenue. Nonetheless, they have subtle differences.
Unearned revenue - also known as unearned income - typically represents long-term liabilities, money received for services or products that are expected to be delivered over an extended period, often spanning beyond one year.
In contrast, deferred revenue is generally associated with shorter-term commitments, where the delivery of products or services is expected to occur within a year.
Well, this revenue offers a clear view of a company's financial obligations to its customers. SaaS companies often receive liabilities for yearly subscriptions, and deferred revenue allows them to account for these payments accurately.
So, you should record the received in advance money as they:
👉🏻 matter in financial compliance,
👉🏻 are essential for transparency,
👉🏻 are vital for accuracy.
When a business receives payment for services or products yet to be delivered, record revenue on your income statement could result in inflated revenue figures and misrepresentation of financial health. As deferred revenue is money received in advance, this can cause many problems.
✒️ Lesson learned: If subscription-based models are the norm in your business, then you will be better off if you understand and manage deferred revenue in order to maximize profitability.
Deferred revenue journal entries in bookkeeping usually involve a debit to increase cash or accounts receivable and a credit to record the deferred revenue as a liability on the balance sheet.
As the revenue is earned over time, a portion of the liability is debited, and revenue is credited on the income statement. Deferred revenue accounts follow GAAP guidelines.
Debit cash or accounts receivable to increase assets and credit deferred revenue as a liability.
As services or products are delivered, debit deferred revenue decreases the liability and credit revenue on the income statement.
Continuously adjust entries to reflect revenue earned, ensuring accuracy in financial statements and compliance with accounting principles.
Since deferred revenue is common practice, let's illustrate a practical, simple example.
Suppose a SaaS company offers an annual subscription for $500. When a customer pays for the subscription at the beginning of the year, the company gets the full amount upfront.
However, as the service is provided over the course of the year, the revenue is not recognized all at once. Instead, it must be spread evenly over the subscription period and performed in the future.
At the beginning of the year, the $500 payment is recorded as deferred income. As each month passes, equal portions of this deferred revenue are recognized as earned revenue on the income statement.
Now you know that deferred revenue is a liability, but what do you want to do with this information?
If you can't come up with any idea, then contact Valueships.
Valueships specializes in guiding SaaS companies through the tricky world of pricing, value-selling, strategy consulting, metrics, and more. This means we can also help your business with a deferred revenue balance.
Our company has been on the market for a long time. Thus, our expertise and experience can help your business navigate the complexities of financial accounting, ensuring accurate and compliant recording of revenue.
With our support, you will be able to:
With Valueships as your trusted partner, discovering how to balance books in the SaaS industry has never been easier.
Deferred revenue - classified as a liability - is more than just a buzzword in SaaS. It's a cornerstone of financial accounting. This financial concept reflects prepayments for goods or services yet to be delivered.
Properly recording it is essential for many reasons, and by seeking expert guidance, you can ensure your financial health remains robust and the revenue streams flow smoothly.
See how Valueships can help you, and get back to us if you need help.
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Certified expert in price, revenue and margin management in B2B companies and e-commerce. Member of the prestigious Professional Pricing Society. At Valueships, he is responsible for the implementation of consulting projects and taking care of the profitability of clients. Prior to joining Valueships, he worked at McKinsey & Company in the area of pricing and strategy.
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Certified expert in price, revenue and margin management in B2B companies and e-commerce. Member of the prestigious Professional Pricing Society. At Valueships, he is responsible for the implementation of consulting projects and taking care of the profitability of clients. Prior to joining Valueships, he worked at McKinsey & Company in the area of pricing and strategy.
