Accounting/Finance Hopping Over Dollars for Dimes: Automating Revenue Recognition is an Investment in a Tool

Accounting is Overwhelmed Without the Right Tools: Revenue Recognition Software Helps

As noted in the “Cloud Accounting Blog,” the role of the CFO and the accounting department in an organization are changing and for the better!

Long gone are the days where finance professionals were type-casted as number crunchers! The “Cloud Accounting Blog” surveyed 500+ CFOs and found that the reoccurring theme of their advice was that finance is no longer just a numbers game, its a value-added game. This higher expectation coupled with additional job tasks defined with a vague term like value-added lends its hand to an important question: what is value added for a finance professional?

 The CFO/the accounting professional is a key playmaker for their corporation. Value is trumping financial gatekeeping and creating a greater need for collaboration. “Value-added” is what the finance professional is providing through collaboration that often occurs amongst not just accountants but with other members of the company. This necessitates the use of tools that allow for finance departments to not only communicate more widely amongst themselves, but also, with those outside of the department for increased transparency. Reports need to be available readily and they need to be easy to digest.

Accounting professionals have found through the use of a SaaS based revenue recognition software, everyone has access to the best numbers reflecting company value. Ease of use should be a priority with that software because not everyone you communicate with is as financially literate as an accountant. Putting yourself in the position to be a key contributor to your company’s goals is the type of positioning that will spur your career. This is done through investing in yourself as much as your company with the tools that allow you to continue making the best use of your time and skills while meeting these new demands in the brave new world of value-added accounting.

Accounting is not the lone wolf department anymore. Accounting departments today possesses key team players contributing to how a corporation operates and makes decisions. The responsibilities added by this shift could potentially overwhelm a department that has not made the small investments in tools such as SaaS that automates revenue recognition all while providing automatic, elegant reports that make this type of collaboration a breeze!

“Cloud Accounting” Blog Post (http://cloudaccountingblog.com/2016/04/12/7-surprising-insights-highlights-from-recent-survey-of-500-cfos/)

88% of the Time Spreadsheets are Wrong and It’s Not Your Fault: The Importance of Revenue Recognition Software

Business-risk interest groups have found that spreadsheets are hotbeds for risk. Spreadsheets have an astronomically high statistical likelihood of containing an error when managing data such as revenue. Let’s talk about how you can quantify this risk specifically to your business.

In 2013, the University of Hawaii’s Ray Panko, as noted by MarketWatch, found that spreadsheets, even after thorough examination for error, contain 1% or more errors for all formula cells. The larger your spreadsheet and this risk compounds. The original article cited an average of 88% of spreadsheets will have an error that is overlooked. Even when one extensively educated, brilliant accountant or finance buff is put in charge and is meticulous in editing, errors are occurring. It’s not reasonable to expect an individual to catch the disastrous error(s) in what is often thousands of cells.

Spreadsheets are great for calculations, but not for routine data! If you are in the technology or Software as as Service industry, as directly cited from renowned BYU professors Jim Stice and Kay Stice, revenue recognition is routine data as it is necessary data! Especially if you are a start-up, revenue recognition highlights the value and potential of your product and company bring to the market. You don’t want any errors on your highlight reel! It will lead to either a devastating drop in your evaluation or an undervaluation. Both are detrimental to growth.

Take the time to calculate/forecast what it would mean for your growth and numbers for an error in revenue recognition that even your best and brightest brightest will statistically miss.

Spreadsheets are going to contain errors: 1% or more for all formula cells and for an average of 88% of spreadsheets. Have your earnings management team automate your revenue recognition with a revenue recognition software. Your highlight reel should speak to your potential, not your potential for error!

(MarketWatch Article: http://www.marketwatch.com/story/88-of-spreadsheets-have-errors-2013-04-17)

(Jim and Kay Stice on Revenue Recognition https://www.lynda.com/Accounting-tutorials/Running-Profitable-Business-Revenue-Recognition/383050-2.html)

Welcome ProRata, Your Revenue Recognition Solution of Choice for Startups and SMBs

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.

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.

 

FASB Revenue Recognition

In May of 2014 the FASB and IASB issued a press release offering joint recommendations regarding revenue recognition (link to press release). This recommendation is especially important for software companies when dealing with customer contracts. Until this guidance was available there was no agreed upon standard between GAAP and IFRS standards.

Why is revenue recognition important for software companies?

Reporting revenue recognition is especially important for software companies in order to understand and assess a company’s current performance and growth potential. Many software companies sell different products and services such as annual subscription agreements, maintenance fees, custom software development, training, and consulting. It is important to clearly define these elements in your contracts and to also recognize the revenue for each of these properly.

Venture Capital

Software companies who might pursue investment from venture capital firms will most likely be asked to provide financials that follow these guidelines. It’s beneficial to start doing this early to avoid re-stating revenue for past years.

Financial Institutions

Financial institutions, much like venture capitalists, will require revenue to be reported that meet these standards. You may be required to prepare statements in accordance to GAAP and provide these as part of your terms for financing.

How should a software company recognize revenue?

The basic criteria for recognizing revenue are:

  • persuasive evidence of an arrangement exists
  • delivery has occurred
  • the software vendor’s fee is fixed or determinable
  • collection of fees is probable

Revenue Recognition for Annual Subscriptions

Revenue for annual subscriptions that are paid up-front should be recognized over the life of the subscription. For instance, a $1,200 annual subscription that starts in January should have $100 of revenue recognized each month for 12 months.

Recognizing Revenue for Software Maintenance Fees

Maintenance fees that are charged to customers should also be recognized ratably over the period of the term, just like annual subscriptions. If you charge $480/year for maintenance fees, then $40 of revenue needs to be recognized each month.

Revenue Recognition for Custom Software Development

If you charge for custom development then based on the criteria for recognizing revenue, you should recognize after the client’s customization have been completed and delivered. In addition, your contract should clearly state when the customer will be billed and how much.

How does ProRata help with revenue recognition?

ProRata is a web-based financial application that works in conjunction with QuickBooks Online to aid companies in revenue recognition.

  1. ProRata can be configured to meet all the recommendations outlined above.
  2. After a one-time setup, entering new subscriptions and other services takes less than a minute.
  3. ProRata integrates directly with QuickBooks to create journal entries, invoices and sales receipts; keeping your books up to date with the current standards
  4. Anyone, even those without a financial background, can use ProRata.

 

Software Startups and Revenue Recognition

Revenue recognition may be a mysterious concept to a lot of software startup founders, but it is an important accounting concept to understand when running a business.

Revenue Recognition Criteria

When a product or service is sold, certain conditions must be met for that product or service to be recognized as revenue. If you sell a 1 year software subscription for $1,200 in January, you can not recognize all $1,200 as revenue in January. It must be spread across the entire span of the subscription.

The criteria for recognizing revenue are:

  • persuasive evidence of an arrangement exists
  • delivery has occurred
  • the software vendor’s fee is fixed or determinable
  • collection of fees is probable

This is especially important for software companies who sell annual software agreements, charge maintenance fees, or do custom software development.

Deferred Revenue

Revenue recognition can be handled by creating a new liability account called Deferred Revenue. This is revenue that you have collected money for, but cannot recognize as revenue yet based on the criteria described above.

The journal entries might look like:

Record the entire amount against deferred revenue

DebitCredit
A/R $1,200
Deferred Revenue $1,200

Each month, recognize 1/12th against revenue

DebitCredit
Deferred Revenue $100
Revenue $100

Why is revenue recognition important for startups?

Venture Capital

Software companies who might pursue investment from venture capital firms will most likely be asked to provide financials that follow these guidelines. It’s beneficial to start doing this early to avoid re-stating revenue for past years.

Financial Institutions

Financial institutions, much like venture capitalists, will require revenue to be reported that meet these standards. You may be required to prepare statements in accordance to GAAP and provide these as part of your terms for financing.

QuickBooks Revenue Recognition

QuickBooks revenue recognition can be a manual process, however ProRata can automate this process for your company.

Continue reading “QuickBooks Revenue Recognition” »