What is revenue recognition (and why do you need it as your agency grows)?

Image for Kate Bastable By Kate Bastable

When you were small, chances are you finished a project, sent the invoice and got paid. But as you grow and start to take on bigger projects and clients, this isn’t always the case. Projects lasting several months, retainers and upfront payments can all play havoc on your balance sheets. This is where ‘revenue recognition’ comes in.

There are any number of reasons why a client might ask you to change the way you invoice or the timings of your billing. It could be to ringfence their budget before year end. It could be for a specific job. Or it could be just as a pot of money they can ask you to work through as needed. This is when your revenue management can start to get tricky. You start to see peaks and troughs in your revenue and struggle to establish true profits for each job.

For example, you might see a high revenue in December when clients ask you to bill for their remaining budget. But you don’t complete the work until the following year. You’ve got the money, but you don’t yet know how much of this revenue is profit. So essentially it needs to sit on your balance sheet but not be declared as profit until you know the figures.

This is where revenue management comes in.

Revenue management gives you a more accurate view of revenue and helps prevent spikes in your profit and loss. It works by assigning (or ‘recognising’) the revenue to the month it’s actually spent, used or going to be spent. And taking into account when costs are spent against the revenue. So you can forecast effectively and track against monthly targets.

You use a system called accruals and deferrals to make sure the revenue is allocated to the right time period.

An accrual means bringing your expenses or revenue forward to the current period. For example, if you’ve completed a project but not yet invoiced, revenue would be accrued against the month the work was done. Equally, if you’ve received goods or services from a supplier for a project but haven’t yet been invoiced, you would still want to record the costs for the correct month.

Conversely, if you invoice or are paid upfront, you need to defer the revenue — take it out of your profit and loss and add it to your balance sheet — and accrue it as and when the work is completed.

Essentially, an accrual brings a transaction forward while a deferral delays it.

When to start thinking about revenue management

It’s always a good idea to have processes in place. But really, as you grow this starts to become essential. You’ll be taking on bigger jobs and bigger clients, which generally means a shift in the way you invoice and receive payments. As soon as you start invoicing in advance of completing work, you need to get your process up and running.

You can do this a few ways. One option is to use a spreadsheet to track the pot of money. Itemise what’s been spent (with dates and details) and what’s remaining. This enables you to calculate how much revenue and costs you can post to your project each month.

But… this relies on someone manually tracking and remembering to add every single detail, which is clearly a mammoth task. Ideally, your agency management software should help make lighter work of this. In my last agency, I used Synergist software which allows you to recognise and defer revenue on individual jobs or all jobs, and run accounts reports at month end, saving us loads of admin time!

Being paid large amounts of money upfront can seem brilliant in theory. But until this money is earned (recognised) you need to manage it carefully. Otherwise you’ll be constantly playing catch-up and could end up operating at a loss. Once you get into the right habits, however, you’ll be able to effectively allocate your revenue and have a clear understanding of profits per project.

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