What’s so Important About Properly Recognizing Recurring Revenue?

There is a huge amount of interest and dialogue these days about Cloud computing and the terrific benefits it brings to businesses, their customers, and consumers. This is not surprising. If you can get the best possible value when you use something, anytime you want it and only pay for what you use, then you don’t have to build it yourself or buy a whole elephant from someone else. I’m sure that most people have a relationship with at least one service provider in their lives today, perhaps the use of mobile services being a great example.

Businesses often provide these services to their customers through subscriptions. They use recurring revenue models that involve billing their customers for these subscriptions and perhaps some occasional additional one-time services. And this raises yet another opportunity for these service providers to excel and differentiate themselves through their “revenue recognition” solution.

What the heck is revenue recognition? Why do we need this? How does it make my life better?

Well, let’s think about this first on a personal level. People who sell a car or a house might be asked “Did you make any money on it?” Or when any of us buy stock we try to “buy low and sell high” to make a profit, because buying high and selling low is just not the desired financial result.

If we think about this on a business level, we recognize that every business needs to measure its financial health and performance in a consistent and meaningful way.  As a general rule, a healthy company makes a profit and grows its profits over time. In order for these measurements to have meaning and for the concept of “profit” to have consistency, we need to match the revenue and the costs incurred to generate that revenue in the same time period, regardless of when the seller’s invoice is issued or the customer’s payment is received.

Now back to the recurring revenue business model and the service provider’s subscriptions.  We see that a subscription service provider incurs costs over the entire term of their agreement, say, over a year.  If we want to measure the health and performance of that service provider’s business, the subscription revenue should be spread out — or recognized — over that entire term too.

And this alignment of revenue and cost produces a lot of great things that are important to every business.  It ensures accurate financial statements regarding sales, expenses, profits, assets, liabilities, and owners’ equity. It enables effective internal operations management practices that deliver great results. Governments at all levels have laws requiring it or relying on compliance, giving investors, stockholders, and employees legal protection from fraud, embezzlement, etc., and guaranteeing accuracy and integrity for levied income, sales, and use taxes.

So when you want accurate financial statements, effective performance measurements, meaningful indicators of healthy practices, and legal compliance, it would probably be a good idea to consciously emphasize proper revenue recognition practices that will align your recurring revenue and the related costs in the right financial period.  Just saying, that’s all.

Let us know how your revenue recognition efforts are working for you!

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