Your accountant might talk to you about this when you are invoicing more significant sums, but it’s worth knowing about the point at which your business recognises its incoming revenue, or turnover. And it can be particularly important if you are paying commission or bonuses to your sales team on revenue generated.
The idea behind revenue recognition is the point at which your business formally registers that it has made a sale and the amount involved - it's entered into the books as unconditional revenue, even if you have not received the cash.
This is normally when the customer has accepted the goods or services that you provide and they cannot be returned for credit or refund.
Some examples:
You sell and deliver your product or service to a customer and receive the cash immediately. The customer doesn't need to approve the shipment - the shipment itself means customer acceptance. You can enter the revenue in your accounts for that month. The cash is received and the revenue is recognised.
You sell and deliver your product to a customer and give them payment terms of 30 days. The revenue can be entered into your accounts for that month even though the cash will come later. This is because the sale is unconditional and your customer has accepted the product or service, they are just going to take their time to pay for it.
You sell your customer an annual service, for which they make one payment in advance. They can cancel at any time with no penalty and receive back the balance that remains. You recognise one-twelfth of the revenue in your accounts month by month and hold the rest of the cash as a pre-payment. In this example you have benefit of the cash but risk having to give some of it back if the customer cancels.
You receive an order for your product, which you have to make for your customer over the next 2 months. You receive a deposit, which is refundable if you don’t deliver the product. Normally you would not recognise the revenue until you deliver the product even though you’ve taken some cash in advance.
This is not an exhaustive list and your particular situation may well be different. Research what your revenue recognition policy should be and build that into your business plan. Savvy investors will want to know what it is.
Of course you might take the view that a sale is not a sale until you have the cash.
Your policy may also have implications for the way you pay bonuses and commission. For example, if a sales exec has sold your product on a sale or return basis, which is not uncommon when you're starting out, then you won't recognise the revenue yourself until the customer confirms that nothing is coming back for credit. It would be a shame to pay a full bonus on the sale of, say, 20,000 products only to see half of them return a while later. It keeps your exec's skin in the game because they will want their bonus and will be pushing the customer. If the bonus is already paid them they'll no longer be interested.
There are a couple of technical terms you might find useful too: Accrued Revenue is where the revenue can be recognised before the cash is received, whereas Deferred Revenue is when cash has been received but the product or service has not yet been fully delivered. It will show as both cash and a balancing liability on your balance sheet until all the money is recognised.
Of course if you do receive the cash in advance, and you're sure you're going to deliver, then this helps your cash runway.
Comments