Revenue Recognition project management news

Understanding Revenue Recognition and Making it Work for Your Bottom Line

Understanding Revenue Recognition

Revenue, surely, is something simple that can be easily calculated. It’s the amount of money you get in versus the amount that goes out. If only it were that simple.

Cash accounting V accrual accounting

Effectively, there are two accounting systems that companies use. Smaller firms, with no more than $25 million in annual revenue, use cash-based accounting. So a company that makes shirts writes down the money it spends on the materials it needs the moment that money goes out of its account. And it then registers its revenue the day they receive payment.

The problem is that if your cash went out in, say, December of last year, and you only received payment in February of this year, your accounts get skewed. If an investor asks to see last year’s accounts, they’ll think you’re doing less well than you really are. But if you show them only this year’s figures, they’ll be misled into believing that things are going significantly better than they actually are.

What is ‘Earned’ revenue?

So the vast majority of businesses use accrual-based accounting. You only register revenue once you’ve fully delivered the product or service promised, regardless of when you actually get paid. Revenue then can only be recognized, from an accounting perspective, once it’s been ‘earned’.

This has particular relevance for large organizations with sprawling projects that can go on for years. And for any company that provides a mixture of products and services.

If, for instance, you’re a large engineering firm working on a five-year infrastructure project, then you’re going to have multiple deadlines, a mixture of fixed and variable costs, and uneven cash receipts and expenses.

Likewise, if you’re a tech company providing your customers with a bundled package, you’re probably producing a software package for which you provide consulting, maintenance and upgrades, and technical support, which you get paid for through a combination of once-off payments and recurring subscriptions.

Inaccurate forecasts and mismanaged resources

Whatever area you work in, you need to break everything down into discreet tasks that can be measured and accounted for in terms of specific deadlines. Because the two areas where businesses end up creating problems for themselves more than any other, are with inaccurate forecasts and the misalignment of project resources.

On the one hand, gaps appear between the predicted costs and provisional timelines, and the actual costs and delivery times that follow. Which has become even worse now because of the spiraling inflation and supply chain chaos which is currently raging across the globe.

And on the other, that inaccurate forecasting leads inevitably to ineffective planning. And what that results in is the mismanagement and misalignment of resources. It’s imperative that you give the right people, with the appropriate skill levels, sufficient time to complete the tasks they’ve been commissioned with. And that they’re supplied with the materials, machines, and inventory to be able to do so.

Which is why it’s more important than ever for organizations to make use of Earned Value Management (EVM) systems wherever possible.

Take charge of your data

All of which depends on you having access to and being able to immediately see all your data. Because delays, waste, and unnecessary cost overruns are almost always the result of poorly managed data. You have to be able to see exactly where everyone is on every project, and where they are in relation to their budgets and timelines. So that whatever problems arise can be addressed as quickly as possible, before they become unmanageable.

Because there’s no magic formula when it comes to running an organization. It’s incredibly simple. Minor things happen, creating small problems. But because those problems get missed, they quietly grow, developing into major issues. What that means in accounting terms is that a task that should have been completed in this quarter has to be deferred until next year. So that particular revenue has not been earned, and cannot be recognized.

The result is that everyone ends up running around in a panic ‘chasing margins’, as they desperately try to fill the gaps in this quarter’s figures created by having to delay recognizing all that deferred revenue.

So it’s absolutely vital that you use the right software package to allow you to take charge of all your data. Once everything is centralized and all your systems have been streamlined, you’ll enjoy immediate visibility into all that all-important data. Your forecasting will get dramatically better, which will help your planning and significantly improve your resource management. All of which will show up in those figures and in the revenue you’re able to get recognized.