Inarguably, revenue is one of the most important metrics used to understand a company’s past financial performance and future prospects. It is the measure that is most often scrutinized by regulators, auditors and investors in trying to assess financial health of an organization.
Revenue recognition is a core component of accrual-based accounting, where revenues (and expenses) must be recognized at the time goods or services are delivered regardless of when cash is received for those goods or services. It sounds simple, but in practice can be very difficult to determine what has been committed, how much, and when revenue should be recognized, particularly for contracts with multiple elements. Additionally, innovative business models, emerging digital industries, and global companies are testing the boundaries of previous revenue recognition standards.
As monetization strategies shift from neatly defined, one-time purchases, to subtler long-term relationships that are built on a combination of ongoing product and service-based cash flow, financial professionals need to define a distinct and automatable process for generating accurate, clear, and thorough financial reports. Booking and revenue recognition policies will need to be clearly documented, adhered to, and maintained. On a small scale, manual processes for revenue recognition will continue to work well, but for higher volume contracts with complex arrangements, including combinations of one-time, subscription and usage services, automating revenue recognition rules will be paramount.
Here are 5 considerations to keep in mind when evaluating software that automates revenue recognition:
New revenue recognition standards are now principle-based, giving businesses a lot of flexibility in how to apply the rules. Your software solution needs to be flexible as well. First, it needs to handle the initial rules you set. As things change over time, the system needs the ability to adjust along with your business and contracts. One of the ways a system can do this is by having the ability to handle multiple element contracts. Modern contracts can have elements of one-time payments, subscription, and usage-based charges in addition to all the other provisions and arrangements. Your solution needs to have the flexibility to handle all these elements without the need for cumbersome customizations.
Having a system with pre-defined structures and rigid processes might be easier or less expensive to implement right away. While the application of revenue recognition comes down to simple mathematics, it is the establishing of the fundamental elements that will trigger how much revenue to recognize and when that must be established first. And once established, it must be continually managed and updated as businesses and markets evolve. It is crucial to have a software solution that can adapt quickly and be configured to meet changing business needs. It also must be agile enough to customize without the need to get in line for an upcoming product release that may be months away.
Doing simple revenue recognition by hand with spreadsheets and staff manpower is easy for small enterprises, but as businesses scale, it is harder and harder to simply throw bodies at the problem. Large enterprises looking to expand quickly must have a solution that can handle rapid growth in volume and velocity of transactions. These systems must scale to support thousands or even billions of transactions, locally or internationally. As companies scale their business, the right solution will scale with them; providing the necessary flexibility in packaging, dynamic pricing and subsequent revenue recognition to continuously drive new revenue.
One of the keys to scale is automation. Automated revenue recognition processes that are built into agile monetization or dynamic billing platforms take much of the human error component out of the order to cash process. This can include automated updating of revenue recognition milestones and the automatic reporting of revenue metrics to key stakeholders. However it is implemented, automated recognition of revenue and reporting must be scalable to not only support a repeatable process, but also be flexible enough to incorporate new technologies as they develop.
Single Source of Truth
The key is to define a single “System of Truth” instead of relying on ad hoc reporting from various systems. It can be the CRM, ERP or the Billing System, but regardless, it is important to have the conversation. In complex situations, often the system of record may be different for different pieces of information. Even though information will be duplicated, it is important to know which system “wins” when they get out of sync. By leveraging a system that includes a product catalog with packaging and pricing, and that can also handle order placement, calculate usage, track billing, produce invoices all the way through revenue recognition, you maintain single source of truth. Having revenue recognition handled natively within a subledger automatically means you maintain clean audit trails. Especially for multiple arrangement contracts with mixed business models, having a single source of truth significantly reduces the risk of errors and the need for restatements of earnings.
As markets become more sophisticated, the processes defining how complex offerings are monetized, billed and recognized are becoming more interdependent. Billing is one touchpoint that is a trigger event in the process of revenue recognition. By understanding how a robust billing system can perform more functions than simply sending invoices, and how an organization can use their billing platform to refine the recognition of revenue from complex monetization, businesses are able to recognize revenue more accurately and efficiently, and mitigate the risks associated with earning restatements.