What is deferred revenue in a SaaS or subscription business?
Why is deferred revenue important?
Deferred revenue is a balance sheet liability account. Deferred revenue is equal to the value of invoices to date over the recognizable revenue to date calculated by customer contract and then aggregated and reported in summary form. Because deferred revenue is a balance sheet item, it is always calculated at a point in time.
Note if the calculation for a contract produces a negative number, the value is included in Unbilled AR, a balance sheet current asset.
How do you calculate deferred revenue?
Let’s look at two examples to illustrate how deferred revenue for a subscription is impacted by invoicing differences.
Example Subscription #1
A one-year 12,000 subscription.
The subscription start date and revenue start date are the same, April 15, 2013
The subscription end date and revenue end date are the same, April 14, 2014.
The subscription is invoiced all on the subscription start date of April 15, 2013.
In this image, there is an invoicing schedule, with one record, and a revenue recognition schedule with a record for each month of revenue recognition over the term. In use is the proper daily amortization schedule.
Period Revenue is the revenue schedule by month, Note that April 2013 is approximately 1/2 the other months because the start date is April 15.
Recognized Revenue as of End Period is the rolling total of revenue recognized as of the end of that month.
“Deferred Revenue Balance as of the End of the Period” is the last column. This displays the value as of the last day of the month. If the schedule were shown in daily records, the Deferred Revenue Balance would be 12,000 as of April 15 and would decline by an equal amount until April 30, where the balance would be 11,473.97, the first row in the revenue schedule table below.
Example Subscription #2
In this example, the only change is that the invoicing is quarterly over the term. The value and dates of the subscription are identical. A one-year 12,000 subscription has an order date of April 1, 2013, a subscription start date and revenue start date of April 15, 2013, and a subscription end date and revenue end date of April 14, 2014.
In the Revenue Schedule table, the values in columns 1, 2, and 3 are identical to that in Example 1 above. The last column, Deferred Balance as of the End Period,” is different. Here you can clearly see the impact of invoicing on deferred revenue. Notice how the value at the end of the period bounces up and down, with peaks in the months where there is an invoice.
What is deferred revenue?
In a nutshell, deferred revenue is an accounting principle whereby revenues from a contract are recognized over time as the services performed.
For example, you sign a 12-month, $12,000 contract with a customer and you invoice the full amount upfront. You recognize the revenue as soon as the invoice goes out the door. You should typically recognize pieces of revenue over time as you perform the service.
In our simple example, how much revenue would we recognize after a month? Well, this is easy. 12-month contract, $12,000. So after month one, we’d recognize about a thousand dollars in revenue and the remaining $11K would put into a liability account sometimes called unearned revenue.
Now, we know what you’re thinking. You’re thinking "A liability? Shouldn’t it be an asset, especially if I already got paid upfront?" Nope. And accrual accounting (the exchange of cash) is largely disconnected from your revenue recognition.
Your revenue recognition is all about your performance obligations. When you deliver the service, if you’ve only delivered one 12th of the service to your customer, you still are on the hook for the other 11/12ths—therefore, a liability that you have an easy rule of thumb to help you remember deferred revenues:
What’s been invoiced - what’s been recognized
Now it is accounting, so there are exceptions in gray areas and landmines and prison shanking in swarms of locusts. But that rule should keep you in straight.
Most situations in my example seem easy enough, but this is only one customer. When you start scaling to hundreds or even thousands of customers and you factor in those pesky exceptions and landmines, we just talked about keeping track of deferred revenue becomes very difficult and error-prone.
At Maxio, we do these complex calculations at scale. So you don’t have to worry about a botched Excel sheet. Get a demo to learn more about how you can simplify your revenue recognition at scale.