Understanding Accrued RevenueLink to this section
Accrued revenue is a critical metric for businesses to assess their current financial position and potential future revenue. It assists in projecting future revenue, budgeting, and supporting companies to make informed financial decisions.
This accounting method offers a more accurate picture of a company’s financial performance because revenue is recognized when it is earned, not when cash is received.
For SaaS companies, there is often a delay between services being supplied and revenue being paid, making accrued revenue an essential metric to track.
By understanding accrued revenue, SaaS founders clearly understand how (and when) cash is coming into your company, what your cash runway looks like, and how to allocate resources in the right places.
Defining accrued revenueLink to this section
Accrued revenue, also known as unbilled revenue, is a financial metric that refers to revenue earned by a business but not yet invoiced or paid for. This means that the business has provided goods or services to the customer, but the bill has not been raised yet.
Accrued revenue is an essential part of accounting that records revenue when it is earned, regardless of whether cash changes hands.
The challenge with accrued revenue is that the invoice hasn’t been raised yet, even though the goods or services have already been provided. Once the invoice is raised, accrued revenue is treated as an account receivable until the customer pays the bill, making it a current asset on the balance sheet.
When does accrued revenue occur?Link to this section
Accrued revenue is recognized when there is a mismatch between the time of payment and delivery of goods or services. This can happen in various cases, such as:
- Long-term projects
- When revenue is booked based on milestones met
The challenge with accrued revenue is that businesses may provide goods or services in the past, but the invoice has not been raised yet. Therefore, an adjusting entry must be posted in the general ledger to recognize the revenue earned in the past.
Accrual accounting requires transactions to be recorded as they happen, regardless of when cash is received or paid. This means that revenue is recognized when it is earned, and expenses are recognized when they are incurred, regardless of the timing of cash flow.
How to record accrued revenueLink to this section
Accounting on an accrual basis provides a more accurate financial picture for a company. That’s because you’re matching revenues with expenses in the same accounting period, reflecting the economic reality of the business operations.
In SaaS businesses, revenue is often accrued in cases such as:
- Upgrades or downgrades
- Add-on purchases during the subscription period
- One-time charges like migration fees or setup fees
Because of the accrual concept, you’ll often have something called an adjusting statement.
Let’s look at an example of this. Remember: services need to be recorded in the accounting records and reported in the financial statements of the periods in which they occur.
SaaS Company A (let’s call them SmartMarketer) has agreed to provide marketing automation software to a customer for 12 months for a sum of $12,000.
According to the contract, the customer will pay $1,000 per month for 12 months. SmartMarketer provides training for the customer at the beginning of the subscription period, which is valued at $2,000. The cost of the training session is not billed immediately to the customer but is marked as accrued revenue for SmartMarketer.
After providing the training session and billing the customer for $1,000 for the first month, SmartMarketer must create the accrued revenue journal entry to record the training session:
Debit: Accrued Revenue - $2,000
Credit: Revenue - $2,000
When the customer pays the $1,000 for the first month, SmartMarketer records the following journal entry:
Debit: Cash - $1,000
Credit: Accounts Receivable - $1,000
To reverse the initial accrual at the end of a subscription period when all payments are received, SmartMarketer company needs to record the following journal entry.
Debit: Revenue - $2,000
Credit: Accrued Revenue - $2,000
On the balance sheet, debit balances associated with accrued revenue are recorded, whereas the changes in revenue are reflected in the income statement.
How is accrued revenue different from deferred revenue?Link to this section
Accrued revenue and deferred revenue are fundamental concepts in accounting that are frequently confused with each other. Let’s look at some of the key differences.
One of the biggest differences between the two concepts is how the revenue is recognized.
- Accrued revenue is recognized when the revenue is earned
- Deferred revenue is recognized after the product or service has been delivered
This means that
- Accrued revenue is typically recognized before cash is received
- Deferred revenue is recognized after cash is received.
The entry of accrued revenue is made when revenue is recognized but payment has not yet been received. This type of revenue is recognized when an invoice is raised, and the payment is expected to be received at a later date.
On the other hand, deferred revenue is recognized when a payment is received in advance, but the delivery of the product or service is scheduled for a later date.
Another difference between accrued revenue and deferred revenue is how they are recorded in the financial statements:
- Accrued revenue is recorded as an asset on the balance sheet
- Deferred revenue is recorded as a liability on the balance sheet
This is because deferred revenue represents unearned revenue that must be recognized as revenue over time, while accrued revenue represents revenue that has already been earned but not yet received.
Why is accrued revenue important?Link to this section
Accrued revenue is an essential concept in accounting that helps businesses anticipate expenses and revenues in real time, monitor their profitability, and identify potential problems well in advance.
This is especially important for SaaS businesses that sell pre-paid subscriptions with services rendered over time, requiring the use of accrual-based accounting.
In the context of SaaS companies, neglecting to account for accrued revenue would lead to delayed recognition of revenue, as it would only occur when invoices are issued, causing an incomplete picture of the business’s financial health.
On the other hand, the use of accrued revenue enables businesses to have a more accurate understanding of how sales are contributing to the profitability and long-term growth of the company.
By recording revenue as it is earned, businesses can make informed financial decisions, monitor profitability in real time, and better anticipate expenses and revenues.
Accurately tracking accrued revenue is essential for SaaS businesses to effectively monitor their financial performance and make informed decisions for the future. In fact, tracking accrued revenue is crucial for budgeting, forecasting, and making informed financial decisions. It reflects a company’s financial performance and potential future revenue.
However, a high accrued revenue can be concerning from a cash-flow perspective as it’s easy to interpret this to mean the business is not receiving payments for its services.
It’s important to strike a balance between accrued revenue and positive cash flow to maintain a healthy financial position as a SaaS company looking to grow or scale successfully.
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