Accrued revenue is an important metric for any business, big or small. It helps you keep track of the money you’ve earned but haven’t received yet. This can help your business make more money now and grow in the future.
But what is accrued revenue exactly? How do companies figure it out? And most importantly, how can your business use this idea to get better at handling its money?
Let’s figure it out.
What is accrued revenue?
Accrued revenue refers to the money earned from providing a product or service, even though the payment hasn’t been made yet. This means that accrued revenue appears as an amount that the customer owes to the business for the transaction.
For instance, consider a landscaping business that agrees to take care of a client’s property for a year. The agreement states that the client will pay INR 45,000 for the entire year, billed quarterly. Even if the landscaping company has completed three months of work but hasn’t billed the client until the end of the quarter, it still recognizes INR 3,750 of accrued revenue each month. This accrued revenue reflects the earnings for the services provided during those months, awaiting the quarterly invoice to be paid by the client.
When do you get accrued revenue?
Accrued revenue typically occurs when there’s a delay between when services or goods are delivered and when the payment is received. This discrepancy can happen in various situations, such as:
- Extended Projects: Revenue is recognized for these projects based on how much of the work has been completed.
- Phased Orders: In cases where orders are fulfilled in stages, revenue is recorded as and when each phase or milestone is achieved.
- Lending Money: When lending funds to others, the interest earned on these loans is counted as accrued revenue, often referred to as interest income.
What are the main accrual accounting principles?
In accrual accounting, operations are guided by two main principles: the Matching Principle and the Revenue Recognition Principle.
- Matching Principle: According to this principle, expenses should be documented in the same accounting period as the revenue they contribute to generating.
- Revenue Recognition Principle: This principle mandates that revenue be recorded during the period it is earned. Revenue is considered earned once the product or service has been delivered.
Accrued revenue’s impact on business performance
Accrued revenue holds significant relevance for businesses involved in lending (like banks) or those engaged in extensive projects or large-scale orders of sophisticated products.
The process of estimating accrued revenue relies heavily on management’s judgment and estimates, making it crucial to scrutinize how these revenues are calculated and recorded. Since accrual accounting can potentially be manipulated by management aiming to embellish the company’s financial performance, it is essential for analysts and investors to grasp the rationale behind the recording of accrued revenue.
Understanding accrued revenue in SaaS accounting
Accrued revenue in software-as-a-service (SaaS), accrued revenue typically arises from scenarios including:
- Subscription upgrades or downgrades
- Additional purchases within the billing period
- One-time fees, such as setup or data transfer fees
Consider a scenario where XYZ Consulting subscribes to ‘ABC,’ a cloud-based analytics service, at a quarterly rate of $900 for a package accommodating five users. Merely ten days into their subscription, XYZ realizes the need to incorporate three additional users into their plan. Simultaneously, they opt for a custom data integration service offered by ABC.
The fees for the added users and the specialized service are not charged to XYZ Consulting on the spot but are recorded as accrued revenue for ‘ABC’ in that period. This accrued amount is then recognized as accounts receivable at the time of the next quarterly renewal.
Differences between accrued revenue and unbilled revenue
The differences between accrued revenue and unbilled revenue lie in the nuances of invoicing and accounting recognition. Here’s a simplified explanation based on the reference:
In terms of Invoice requirements:
- Accrued Revenue: As explained before, this is money that a business has earned from its services or products but hasn’t been paid yet. Importantly, it doesn’t necessarily require an immediate invoice to be issued because the service or product has already been delivered, and the transaction is already recognized in the accounting system. The implication here is that an invoice may already have been sent, or the revenue is recognized without the need for an immediate invoice.
- Unbilled Revenue: This refers to earnings that have been generated from products or services provided but for which an invoice has not yet been issued. The key difference is that for unbilled revenue, issuing an invoice is a required step for payment to be processed. This means the revenue is recognized, but the formal request for payment (invoice) has yet to be sent to the client.
In terms of recognition in the Accounting System:
- Accrued Revenue: When revenue is accrued, it’s recognized in the accounting system as earned, affecting the financial statements by increasing revenue and accounts receivable (or cash, depending on payment terms). This is done through a journal entry that credits revenue and debits accounts receivable, reflecting the expectation of payment.
- Unbilled Revenue: For unbilled revenue, the initial recognition involves crediting revenue and debiting an unbilled receivables account, indicating that the earnings are awaiting invoicing. Once the invoice is issued, the accounting treatment shifts from unbilled receivables to regular accounts receivable, indicating a formal request for payment has been made to the client.
Also Read: What is Total Contract Value and how to calculate it?
How to record accrued revenue?
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Accrued revenue is recognized in the financial statements through an adjusting journal entry, listed under current assets on the balance sheet and as earned revenue on the income statement.
When payment is received, an adjusting entry updates the asset account for accrued revenue, impacting only the balance sheet, not the income statement.
Consider this example: XYZ Pvt. Ltd. agrees to develop a custom CRM system for ABC Enterprises over a period of 12 months, for a total fee of ₹9,00,000. The agreement specifies that XYZ is to deliver the first phase of the CRM system in 6 months, valued at ₹4,50,000. The final phase is to be delivered in the next 6 months, marking the completion of the contract.
The billing terms allow for a single invoice at the project’s conclusion for ₹9,00,000. Thus, upon completing the first phase at the 6-month mark, XYZ needs to record an accrued revenue journal entry to account for this milestone:
| Debit | Credit | |
| Revenue Account | ₹4,50,000 | |
| Accrued Revenue | ₹4,50,000 |
Upon project completion and billing the client ₹9,00,000, XYZ reverses the initial accrual with a journal entry and records the invoice amount:
| Debit | Credit | |
| Accounts Receivable | ₹9,00,000 | |
| Revenue Account | ₹9,00,000 |
Accrued revenue best practices
Following best practices for managing accrued revenue is crucial for maintaining accurate financial records and ensuring the smooth operation of a business. This is particularly true for SaaS companies and other businesses that rely heavily on subscription model or project-based billing. Here are some key strategies:
- Precise Recording: It’s vital to adhere strictly to recognized accounting standards for revenue recognition, making sure all revenue entries are well documented in your financial records.
- Prompt Invoicing: To avoid any lag in recognizing revenue, invoices should be issued promptly and accurately, reflecting the completion of services or delivery of products.
- Frequent Reconciliation: Regular checks should be performed to ensure that all accrued revenues are correctly recorded and there are no discrepancies in your accounts.
- Informed Forecasting: Businesses, especially in the SaaS sector, should base their resource planning and growth projections on accurate and realistic revenue forecasts, derived from historical data and observed trends.
- Routine Audits: While maintaining detailed documentation is essential, periodically reviewing your financial records helps verify the correctness of your revenue recognition practices and allows for timely adjustments.
- Clear Communication: Ensuring open and effective communication within your team and across departments is crucial for the accurate and timely recognition of revenue.
- Implementing Robust Accounting Software: Leveraging reliable accounting software can simplify the management of accrued revenues, making the process more efficient and less prone to error.
- Tracking Customer Payments: Keeping an eye on how and when customers fulfill their payment obligations can help in making more accurate decisions about accruing revenue, based on their payment behaviors.
Why is accrued revenue important?
Accrued revenue is crucial because it provides a more accurate picture of a company’s financial health. This accounting practice ensures that revenue is recognized when earned, not just when cash is received, allowing financial statements to truly reflect a business’s performance. This accuracy is vital for not exaggerating or diminishing a company’s financial position.
The significance of accrued revenue includes:
- Ensuring financial reporting consistency over time.
- Boosting a company’s cash flow projections.
- Maintaining accuracy and adherence to accounting standards.
- Offering a realistic view of cash flow to investors and lenders.
- Enabling businesses to see how sales impact profits directly.
- Assisting in identifying and addressing potential financial challenges.
This concept is widely applicable across various sectors, making it a fundamental part of financial management for numerous industries:
- Financial Sector
- Real Estate
- Construction
- Contracting
- Service Industries
- IT
- Healthcare
- Manufacturing and Production
Each of these industries benefits from the clarity and accuracy that accrued revenue provides, making it an essential part of financial reporting and management.
Conclusion
Managing accrued revenue with best practices is essential for any business aiming to maintain accurate and transparent financial records. For companies, especially those operating in the SaaS domain or engaging in subscription-based or project-oriented billing, these practices are not just beneficial but fundamental to their financial health and operational stability.
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Also read: What is Pay-As-You-Go pricing? How it works?
