Article What's the Difference Between Revenue and Deferred Revenue?
When is the money our company is earning really “our money”?
This is a common and quite tricky financial question for B2B Saas companies and their founders today, particularly with advanced reporting standards such as ASC 606. Companies must remain in compliance at every step.
In this article, we will explore the difference between revenue and deferred revenue, shedding light on their definitions, recognition, and significance in financial reporting.
Recognizing the Differences
When it comes to financial operations for B2B SaaS, analysts draw a distinction between revenue and deferred revenue.
The key differences between SaaS revenue and SaaS deferred revenue lie in their recognition and timing.
Revenue is recognized when a transaction is complete and performance obligations are fulfilled, whereas
Deferred Revenue represents advance payments received and is recognized gradually as obligations are met.
Understanding these two concepts is required for accurate financial reporting and decision-making with SaaS.
To get a deeper perspective, let’s drill into the definition of each type of revenue separately.
Revenue: The Lifeblood of Business
Revenue is the most important number on a P&L (“Profit & Loss Statement” or “Income Statement”). It results from the core activities of a business, such as the sale of goods or services. Revenue provides an indication of a company's ability to generate income and sustain its operations.
Payments Received as Goods or Services are Delivered
Revenue reflects the top line of a company's income statement or profit and loss statement. SaaS revenue is recognized when the performance obligations have been fulfilled. Revenue represents the income earned by a company during a specific period, such as a month or quarter or year.
Revenue can come from various sources, such as the sale of products, fees for services rendered, rental income, licensing fees, royalties, and interest earned on investments.
Revenue is used in assessing a B2B SaaS company's financial performance. It is a great metric for analyzing growth trends, evaluating profitability, and comparing the performance of different businesses within the same industry.
Deferred Revenue: Timing is Everything
Deferred revenue for SaaS, also known as unearned revenue, refers to the advance payments received by a business for goods or services that will be provided in the future.
This concept arises when a company receives payment before delivering a product or service. It represents an obligation to deliver products or services in the future.
As the obligations are fulfilled, the deferred revenue is gradually recognized as revenue.
Payments Received In Advance
When a SaaS company receives payment in advance, it records the amount as deferred revenue on its balance sheet. Unlike revenue, deferred revenue is a liability on the balance sheet until the performance obligations are met.
This liability account indicates that the company has an obligation to fulfill its promises to customers by delivering the goods or services they have paid for.
Deferred revenue arises in various business scenarios, such as subscription-based services, prepaid maintenance contracts, advance ticket sales, or long-term service contracts.
For example, when a software (SaaS) company receives an upfront payment for an annual software subscription, the revenue is recognized gradually over the subscription period. Until the services are delivered, the unearned portion of the revenue is classified as deferred revenue.
As a company fulfills its obligations by delivering goods or services, it gradually recognizes deferred revenue as earned revenue in its income statement. The revenue recognition occurs proportionally or as specified by the terms of the agreement.
This process aligns the recognition of revenue with the actual delivery of goods or services and ensures accurate financial reporting.
Businesses must carefully manage and track deferred revenue to ensure proper revenue recognition and fulfill customer obligations appropriately.
Managing Financial Operations
Proper financial management for B2B SaaS necessitates effective management of revenue and deferred revenue. Businesses must ensure accurate tracking, recording, and reporting of both to maintain transparency and compliance.
Failure to do so can lead to misleading financial statements, tax returns, potential legal issues, and misinformed business decisions.
There have been big shifts in recognition standards over the years, most recently with ASC 606 and IFRS 15.
Let’s look at these recognition standards and their highlights.
Revenue Recognition Standards ASC 606 and IFRS 15
Recognition standards have significant impacts on the financial statements of Software as a Service (SaaS) companies.
These are relatively new frameworks for recognizing and reporting revenue, aiming to improve comparability and transparency across different industries.
Four of the most important recent standards changes are below. Now you have an understanding of the difference between revenue and deferred revenue, the requirements below will be easier to comprehend.
- Changes in Timing of Revenue: Under previous standards, SaaS companies often recognized revenue over the duration of the contract. ASC 606 and IFRS 15 now require companies to recognize revenue based on the transfer of control of the goods or services to the customer. This can result in a change in the timing of revenue recognition, particularly for SaaS companies with multi-year contracts.
- Performance Obligations and Contract Modifications: ASC 606 and IFRS 15 require SaaS companies to identify performance obligations within a contract. A performance obligation refers to a distinct and separately identifiable good or service to be provided to the customer. SaaS companies need to evaluate their contracts carefully to determine the performance obligations and allocate revenue accordingly. Additionally, if there are modifications to the contract, companies must reassess the allocation of revenue.
- Variable Consideration: SaaS contracts can often include variable consideration elements such as discounts, rebates, or usage-based fees. Under new standards, companies need to estimate and include variable consideration in the transaction price if it is probable that there will not be a significant reversal in future periods. This can introduce a lot of complexity in revenue recognition.
- Capitalization of Implementation Costs: ASC 606 allows SaaS companies to capitalize certain incremental costs incurred to obtain a contract, such as sales commissions. These costs are recognized as an asset and amortized over the contract period. However, guidance is specific about the types of costs that can be capitalized. It requires companies to assess whether the costs are directly attributable to obtaining the contract.
Luckily, advanced software like TrueRev now exists to make the headache of ASC 606 and IFRS 15 compliance go away with a few clicks.
TrueRev has been a gamechanger in saving time and reducing errors for B2B SaaS companies who try to maintain their revenue recognition and deferred revenue calculations within spreadsheets.
Distinguishing between revenue and deferred revenue is crucial for understanding a SaaS company's financial health and performance. Revenue represents income generated from completed transactions, while deferred revenue highlights advance payments for future obligations.
Recognition standards are putting increasing pressure on financial operations for SaaS to keep their financial statements error-free and up to code.
Fortunately, accounting software like Quickbooks Online can now be directly synced with TrueRev to allow for effortless deferred revenue recognition and to generate financial SaaS metrics.
Proper management of revenue and deferred revenue means accurate financial reporting. This enables powerful, informed decision-making for businesses.
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