The Importance of Accurately Calculating Deferred Revenue

Contributors: Amol Ghemud
Published: January 5, 2023

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Introduction to Deferred Revenue

Every company or business looks forward to earning revenue in order to grow its financial health. Companies require a consistent flow of revenue to manage expenditures, pay vendors, or even make capital investments. An intangible income may result in a misleading company image, and this is where ‘Deferred Revenue’ comes into the picture.

Deferred revenue, also known as unearned revenue, is the advanced payments acquired by the company in return for the goods and services it will provide in the future. The pre-payment that a company receives reflects the amount on its balance sheet as deferred amount or deferred revenue.

Companies and businesses offering subscription-based services usually ask for pre-payments. Deferred revenue is known as a liability since it is non-earned income (goods and services are provided over time). Examples of deferred services include taxes, payment for a service, deposit for future services, legal fees, advance rent, advance insurance, ticket selling, and so on. A company records a current liability if the products and services it delivers are within the period of 12 months. If the period exceeds beyond 12 months, the company records it as a non-current liability. 

Why is ‘Deferred Revenue’ significant?

Deferred value is essential to report the liabilities and assets on a balance sheet accurately. The company avoids reporting unearned income in the asset by reporting referred revenue specifically on the liability side of the balance sheet.

The referred amount is essential as it lets the company be aware of the amount it owns. There is no doubt in stating that cash is the safest asset for the company. However, cash earned from the deferred revenue remains unearned unless the company delivers the services and products on the given time. 

Deferred revenue relieves the burden of asking for a loan and holds high significance for the company or business as they finance operations.

There are chances where customers may delay their payments due to some reasons; this, in turn, impacts the company’s overall financial performance. Reporting revenue as and when the company earns helps companies gain a stable income for the long run.

How to calculate Deferred Value?

The referred amount can be called as the sum of amounts paid as retainers, customer deposits, and other advanced payments. An increase in referred amount means an increase in advanced payments and additional deposits, and a decrease in the referred amount defines a reduction in the amount of revenue earned during the accounting period.

Examples of ‘Deferred Revenue

  • One of the examples of deferred revenue is online retailers. They charge the customers through online payments, debit or card payments, before shipping their order to them.
  • The automobile industry takes deposits on cars for car dealerships several weeks and months before the delivery.
  • A start-up company takes the pre-order to pay for its first manufacturing run of orders.
  • Newspapers and magazine publishers ask for advance payments from their customers in return for the annual services they’ll provide throughout the year.
  • Phone companies ask for advance payment in return for their pre-paid services.
  • One of the forms of referred income is the monthly insurance premiums.

Limitations of Unearned Revenue

Some companies tend to combine the unearned revenue with the actual revenue, which is a liability, and this can result in false profitability numbers with a wrong idea of growth.

In case of high demand, a business or company may find it challenging to deliver the products and services on time, even after receiving pre-payments.

After receiving a pre-payment, it is essential on the company’s side to deliver quality products and services at the specified time. If the quality of the service is compromised, it may result in losing customers, thereby degrading a company’s growth.

Wrapping up

Deferred value is significant for precisely reporting the liabilities and assets on a company’s balance sheet. It is critical in order to avoid misreporting of assets and liabilities. Companies are expected to provide the right quality of goods and services in return for the pre-payments. When the company uses the revenue appropriately, the overall growth of the company is improved, and the finances are all managed and covered. 

FAQs

1. What is the formula for calculating deferred revenue?

Deferred value can be stated as the value of invoices minus the recognized value. 

Deferred Value = The value of invoices – Recognised Value

This is the basic deferred value formula. However, this formula may differ for different businesses depending on their business models. 

2. What is total deferred revenue?

The total deferred revenue is the total amount a company receives beforehand in return for the goods and services it’ll be offering in the future. Other terms that signify deferred revenue are unearned revenue, unearned income, or deferred income.

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About the Author

Optimizer in Chief

Amol has helped catalyse business growth with his strategic & data-driven methodologies. With a decade of experience in the field of marketing, he has donned multiple hats, from channel optimization, data analytics and creative brand positioning to growth engineering and sales.

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