Revenue is one of the most important cornerstones of your business finances. While it is not the only indicator of your company’s financial health, it is the raw material from which you make profits. If money isn’t coming into the business at a steady rate, you won’t be able to pay your vendors, manage your overhead costs, or make capital investments that will help you take your business to the next level.
Consistent revenue is crucial in maintaining a healthy cash flow. But the exchange of products and services with money isn’t always as simultaneous as we’d like it to be. Sometimes our revenue may not be tangible, leading to a false impression of our business’ financial health.
It’s crucial to understand the difference between accrued and deferred revenue and how to factor them into our accounting.
Accrued revenue explained
Accrued revenue refers to goods or services you provided to the customer, but for which you have not yet received payment. Most of the time, accountants will list this revenue with “accounts receivable” on their balance sheet at the time of the transaction. This can be (and often is) done before cash payment has been received, and usually before an invoice has been raised.
While the revenue is now on your books, it is not yet liquid and you do not have access to it.
Example of accrued revenue
There are many examples of when this accrual method of account is used to account for inbound revenue. Some common examples include:
When a utility provider supplies electricity or gas to a customer who has not yet received their bill
When a SaaS company provides a service for which the month’s payment has not yet been received
When a bond investment’s interest is earned, but not paid until a later accounting period
When an accountant prepares a client’s tax return but has not yet raised an invoice or received payment
When a graphic designer submits a piece of work for an agreed price. The client grants final copy approval but the graphic designer has not yet raised an invoice or received payment
What is deferred revenue?
Deferred revenue (also called unearned revenue) is essentially the opposite of accrued revenue. When revenue is deferred, the customer pays in advance for a product or service that has yet to be delivered. The entry is reported on the balance sheet as a liability until the customer has received (and is satisfied with) the goods or services rendered.
Example of deferred revenue
Deferred revenue and deferral accounting lend themselves naturally to several business models. Some common examples of deferred revenue that we see day to day include:
When an e-commerce company receives an online payment for goods that they will later send to the customer in the post
When an insurance company receives a premium for the next 12 months of protection
When a contractor accepts a portion of the cost of the job upfront and defers the remaining balance until the project has been completed
A subscription box company receives advance payment for a year’s subscription, but no boxes have yet been sent out to the subscriber
Understanding the difference
It’s important to understand the difference between accrued and deferred revenue, as it helps you determine how much of your revenue is liquid and how much of it is technically a liability.
Assuming that all revenue is liquid cash can be a dangerous habit to get into, especially when less than satisfied customers start asking for refunds. By accounting for both accrued and deferred revenue properly, you can maintain a healthy cash flow and prevent your business from spending money that is not yet yours to spend.
We can help
If you’re interested in discovering more about accrued revenue, deferred revenue, or any aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.