Deferred Revenue is revenue that you have not yet earned, but that you’ve received in cash. Revenue should not be reported in your profit & loss statement until you have actually done the work to earn that revenue. However, often you receive some or all of the money up front for a project that you have not yet completed.
Deferred Revenue is a liability for your business. Since your customer has paid you funds for doing some work or delivering some product to them, you have a liability to perform that work or deliver that product before that money is really yours. If you would fail to deliver on your agreement, you would owe that money back to your customer. This Deferred Revenue liability sits on your balance sheet until you have earned the revenue.
Sometimes deferred revenue is deferred until it’s earned all at once. For example, if you’re selling a car and you collect a deposit on that car, you earn the full amount of that deposit on the day you deliver the car. It is pretty difficult to deliver less than a full car. However, in other cases, you may be earning the revenue over time. For example, if you receive a deposit on a construction project, then you may earn that revenue over a period of time as the work is getting completed. You may have received $50,000 up front for a project that is going to take 5 months. You may decide that it makes sense that you’re earning $10,000 per month because you are consistently working on that project. Or, you may decide that you earn $25,000 after month two because you completed a large portion of the work, but you earn smaller amounts in the following months because you’re doing less of the heavy lifting in those months.
Impact to Your Financials
When you receive funds from a customer for revenue that is not yet earned, you will increase your cash in your bank account and increase your liability on your balance sheet. There will be no effect to your profit and loss statement at the time you receive the funds.
As you earn the revenue, based on the performance of work, you would then increase your revenue on your profit and loss statement and decrease the liability on your balance sheet. Once a project has been fully completed, there should no longer be any deferred revenue for that project on the balance sheet and you should have recognized the full amount in your profit and loss.
Deferred revenue can be a difficult concept to grasp, but in it’s simplest form, it is a liability that you owe to your customer because you have received funds from them, but have not yet delivered your product or service.
Written by: Shauna Huntington