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The Importance of Revenue Recognition

As a small business owner, you may have to do some basic accounting functions, but chances are you’re not terribly well-versed in the ins and outs. That’s OK … but no matter how skilled or new you are to keeping the books, there’s one key area you must pay special attention to:

Revenue recognition.

It sounds like a simple concept – perhaps just what happens when you get paid – but revenue recognition isn’t quite as easy as it seems. It’s important to understand this term, as well as how to properly record it.

The “why” is much easier to digest than the “how.” Recognizing revenue properly is a key to accurately measuring your financial performance. Stakeholders are going to be interested not only in recognized revenues, but everything you use those revenues to calculate later: profits, cash flow, etc.

How you go about recognizing revenue is a bit more confusing.

To recognize revenue, you don’t actually need a payment in hand. But you do need to fulfill several criteria:

  • Possess some sort of evidence (such as a contract) that another party has agreed to pay you for goods or services.
  • Actual delivery of said goods or services.
  • How you’re charging is clear: For instance, if you deliver monthly and are paid monthly. Of course, there are other arrangements, such as billing on a usage basis.
  • Good reason to believe the other party will pay.

What’s important to note is that actual payment isn’t part of any of these steps. The key to revenue recognition, weirdly enough, isn’t getting paid – it’s simply earning the right to be paid.

For the record, you obviously want to get paid, but payment on time is ideal. Late payment means you have less of a credible reason to believe someone will pay on time in the future, making it difficult to recognize future revenues from late-paying customers. Even early payment isn’t necessarily “good,” because if you’ve been paid before you deliver, you could end up in a situation where the customer doesn’t like your product or service, and thus you can’t count on that revenue occurring again in the future.

If that sounds complicated, that’s because it is. Revenue recognition, while important, is also difficult to get right. Not to mention it’s important to be consistent in how you recognize revenue quarter after quarter. But you don’t have to go it alone – ask the experts. McManamon & Co. provides accounting services to small and mid-size businesses, which includes helping produce financial statements and balance sheets you can trust.

Make sure your data is correct from the get-go – that means getting revenue recognition nailed down pat. Call McManamon & Co. at 440.892.9088 or contact us online.

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