The Revenue Recognition Pain

Revenue recognition rules might go down as one of the most “accounting-iest” concepts out there. You’re telling me that after a customer pays money for something just sold, specific rules need to be followed to record that revenue correctly in the financial statements? Well, if you report your financial statements on an accrual basis (and you should be if you are a growing company), the answer to that question is “yes.”

An Accounting 101 definition of revenue recognition simply dictates that a company cannot recognize revenue until the goods being sold or the services being provided have been delivered to the customer. Software has always been more complicated from a revenue recognition perspective, so much so that PwC had to release a 300 page “user friendly” guide to assist. Fortunately, that guide is more aimed at large, public companies with complex software licensing, not smaller, private companies with a subscription based revenue model.

Subscription based software revenue recognition is pretty simple: you must recognize the total amount the customer pays evenly over the term of contract. Let’s break this down using the same dollar amount a customer pays over three different contract terms. Say a customer pays $1,200 to use your software over these three different terms:

  • Monthly contract – The $1,200 can generally be recognized in full right when invoiced or charged since the customer will have access to use the software for the next 30 days.
  • Quarterly contract – You will have to recognize $400 a month for the three month term of the contract.
  • Annual contractYou will have to recognize $100 a month for the twelve month term of the contract.

As you can see, this isn’t nearly as scary as it sounded earlier in the blog. However, this is where the pain kicks in: how do you actually make this happen in your accounting software? For as great as Quickbooks might be at providing a cheap and effective accounting solution, it cannot automate this task. So here are your options:

  • Set up recurring journal entries on the front end. This requires multiple tedious steps and also presents a reconciliation nightmare if a human error occurs somewhere along the way or something changes. Not scalable.
  • Create a revenue recognition worksheet in excel. This is better, but it still requires additional work to build and maintain if you want to scale it. Not to mention, there is still a risk of error if one measly formula goes out of whack. Not 100% scalable.
  • Pay minimum of $12,000 a year for a clunky enterprise accounting software to automate. Nope.

Here’s where ProRata saves the day. ProRata integrates with Quickbooks to automatically create and record the correct revenue recognition journal entries for each contract. The real beauty of this is that ProRata sets up this automation upon creation of the customer invoice — no extra steps needed!  ProRata can be so powerful for a growing company by saving time, eliminating reconciliation headaches, and improving financial statement accuracy.

Proper revenue recognition is a necessary evil for a growing subscription based company. But this evil becomes less daunting when you have the power of automation at your fingertips.

Are You Leaving Millions On The Table By Making This One Mistake?

Many startup founders we’ve spoken to at ProRata started out (or are currently) tracking revenue in a cash-basis. They soon realize the value in switching to an accrual-based revenue model.

Cash vs. accrual accounting

Simply put, cash based accounting would say that you recognize revenue as soon as you receive payment for it, regardless of when the service was performed.

Accrual based accounting recognizes revenue when the service is performed, even if it is pre-paid or on Net 30 terms. It it especially important for software companies who collect pre-paid subscriptions to understand how to recognize revenue over the life of the subscription.

Don’t leave money on the table

In a recent article on SaaStr, Anita Kutlesa talks about a CEO who lost several millions in his purchase price because revenue had to be converted from a cash-basis to accrual-basis at the time of sale. It’s important to understand how revenue should be recognized and to maintain your books on an accrual basis.

Don’t wait!

The earlier you start properly recognizing your revenue, the less headaches you will have in the future. You will save money by avoided re-reporting revenue and you will have a true snapshot of your company’s revenue. ProRata helps software companies who use QuickBooks to simplify and automate revenue recognition.

Are you aware of how your finance staff is spending most of their time?

In a recent study by the APQC found that finance workers spend 50% of their time doing transaction processing. That’s half of their day! Here are the results of the study.

 

how finance people spend their time

 

“This means that in an average work week, highly paid finance staffs are spending the equivalent of Monday morning through lunchtime on Wednesday making sure that bills get paid, customers get accurate invoices, general accounting work gets done, and fixed assets are accounted for, among many other tasks that keep the money moving through an organization.”

Mary C Driscoll, Senior Research Fellow at merican Productivity and Quality Center, via CFO.com

What would executives and board members prefer their finance staff to be doing?

According to the articles this time spent doing transaction processing, maintaining internal controls and financial reporting doesn’t leave much time for decision support and strategy, the area most executives need focus in.

Companies are looking for ways to spend less time on transaction process and other menial tasks and focusing their highly talented financial staff in decision support.

This problem exists in not only large companies, but even SMBs and startups. The less time spend doing menial tasks by finance staff, the more time that can spend helping to grow the company.

 How Automation of Menial Tasks Can Free Up Resources

Applications and technologies can automate processes and free up valuable time spent doing menial tasks such as revenue recognition. Even with today’s stats of 50% of staffs time being spent on transaction processing, that number used to be a lot higher. Automating menial tasks can free up resources and allow finance staff to be more productive and contribute to strategy and decision support.

 

3 signs you are outgrowing your revenue recognition spreadsheet

If you are similar to a lot of software companies who need to track deferred revenue, you’ve probably at some point created a complex spreadsheet to aid in the process. As your company grows you start to feel the pain of maintaining the spreadsheet in conjunction with your accounting system. Here are some signs that you have outgrown your Excel spreadsheet for tracking revenue recognition:

1. You no longer enter individual journal entries in your accounting system

Your revenue recognition spreadsheet is a work of art. You have tediously spent hours in Excel creating formulas to accurately calculate revenue recognition schedules for your business. You are able to track each customer and each subscription that you have sold. At the end of every month you log in to QuickBooks and proceed to create journal entries for each of your hard earned customers.

Eventually, as your company grows, it is not feasible to manually enter each journal entry individually. You decide to sum up all of the earned revenue for the month and enter it as a single journal entry.

You have now lost details about which customers and which services/products the revenue is attributed to. You have lost the ability to report that detail from your accounting system.

2. Reporting revenue requires combining reports and spreadsheet data

It’s time to run a P&L report or A/R aging report and you’re forced to pull of your revenue recognition spreadsheet for some of the details. Without finer details of each customer and product/service you’re having to rely on data from your spreadsheet to complete your report.

3. You are not able to view a timely snapshot of your revenue

It’s the end of the month and you start pulling reports from Salesforce, Stripe, or some other system to get a clear picture of your new revenue. You use this information to start entering new business into your spreadsheet. What happens when you need to get a snapshot of your revenue mid month?

5 Steps to Recognizing Revenue

The FASB has released an accounting standards update (ASC 606) titled “Revenue from Contracts with Customers (Topic 606)” which outlines how software companies should recognize revenue:

  1. Identify contracts with a customer
  2. Identify the separate performance obligations in the contract
  3. Determine the transaction price
  4. Allocate the transaction price to the separate performance obligations
  5. Recognize revenue when your company satisfies each performance obligation

Experts recommend understanding the impact of the new revenue recognition standard and prepare for the transition. Here are some tips on preparing for the transition:

  • Gather stakeholders across departments (Sales, Operations, Finance)
  • Discuss current practices for revenue recognition using the 5 steps above and discuss how the changes affect each department
  • Implement a plan to properly recognize revenue in your accounting system. ProRata enables users of QuickBooks Online to automate their revenue recognition process.