Basic, lesson 1 of 3
Revenue recognition and where growth hides
Revenue is recorded when the company delivers, not when it bills or collects. The gaps between the three are where analysts find both early warnings and hidden strength.
9 min, 3 checks
1Delivered, billed, collected
The rule in plain words: a company records revenue when it has done what it promised the customer, in the amount it expects to be paid. A contract with several promises (hardware, installation, a year of support) is split, and each piece is recorded as it is delivered.
Billing and collection run on their own clocks. Bill before you deliver and the cash sits in deferred revenue, a liability. Deliver before you collect and the gap sits in accounts receivable, an asset.
Worked example
An annual contract billed up front
- 1Orbiton Software signs a $1.2 million one year contract on October 1 and bills it all that day
- 2Its fiscal year ends December 31, so three of twelve months are delivered
- 3Revenue this year: 1.2 x 3 / 12 = $0.3 million
- 4Deferred revenue at year end: 1.2 - 0.3 = $0.9 million
Cash of $1.2 million came in, revenue of $0.3 million was recorded, and $0.9 million waits on the balance sheet to become next year's revenue.
Check 1
A two year contract worth $480,000 is billed in full on July 1. The fiscal year ends December 31. What is deferred revenue at year end, in thousands of dollars?
2Billings: the number subscription analysts watch
Revenue in a subscription business is smoothed by design, so it moves slowly. Billings show what was invoiced in the period, which leads revenue.
Billings = Revenue + Change in deferred revenue
A rough measure. Changes in contract length and billing terms move it without any change in demand.
Check 2
Quarterly revenue is $500 million. Deferred revenue rose from $200 million to $260 million. What were billings, in millions of dollars?
3Gross or net
A marketplace that sells a $100 ticket and keeps $15 can report $100 of revenue with $85 of cost (gross), or $15 of revenue (net). The rule turns on whether the company controls the good before it passes to the customer. Profit is the same either way. Revenue growth and margins look very different.
| Gross | Net | |
|---|---|---|
| Revenue | $100 | $15 |
| Cost of revenue | $85 | $0 |
| Gross profit | $15 | $15 |
| Gross margin | 15% | 100% |
Check 3
Two travel sites have the same bookings and the same profit. One reports gross, the other net. What should you compare them on?
Terms in this lesson: Deferred revenue, Accounts receivable, Balance sheet, Gross margin.
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