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How to use revenue recognition effectively for your subscription business

Generating revenue is essential for any business. But especially in the subscription business, revenue recognition is a big challenge and requires a clear strategy. What is it all about? And what makes the topic so important for subscription business models? Here is a brief overview: 

What is revenue recognition?

Revenue recognition is usually associated with the terms ” turnover realisation” or “turnover recognition”. It is an accounting principle. If we take a closer look at the term: revenue means income, while recognition is also interpreted as ” identification” or “detection”. Revenue recognition is a special topic in accounting, because it specifically deals with the question of when a turnover was realised and in what amount. So when were the revenues generated by the company? 

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The complications of revenue recognition

The topic of revenue recognition is of great importance for the subscription business. The reason lies in the specific business model. If, for example, one assumes a subscription model for which monthly fees of 15 euros plus VAT are incurred, the question arises: When are the revenues to be recognised by the company? At the time of payment? At a certain cut-off date? And what happens if, for example, a customer books a different package or cancels? What if a different payment interval is chosen? Or the customer has a complaint and wants to revoke the entire contract? 

 

All these factors can have an impact on the company’s revenue development. When a customer goes into a shop and buys a TV, the case is quite simple. It is pretty easy to determine when the revenue has been realised. But subscription business models bring more complexity. Therefore, clear rules are needed for revenue recognition.

Why is revenue recognition important?

First of all, for compliance reasons alone, it is important for companies to proceed correctly with revenue recognition. After all, turnover realisation has an impact on reporting. Companies must ensure compliance and follow the corresponding legal requirements and standard guidelines (US- GAAP, IFRS). 

Beyond the fact that companies are obliged to keep proper accounts, external stakeholders, such as investors or credit institutions, are also interested in the figures. The sales revenues of a company are regularly of particular interest. For example, comparisons can be made: 

 

  • Was the company able to increase its revenue compared to the previous year?

 

  • How high are the sales of direct competitors in the same period under consideration?

 

Of course, knowledge about revenue is also important for the company itself. Strategic decisions are made, among other things, on the basis of turnover developments. 

Data analyses are vital, especially in the subscription business. For example, an increasing number of subscriptions can influence the revenue development and thus the entire company growth. But in order to successfully manage the business model, decision-makers need detailed knowledge of turnover realisation. Revenue recognition is a challenge, especially in the subscription business – but at the same time it brings with it exciting analysis possibilities. 

What are the different types of revenue recognition?

There are various revenue recognition types known in international accounting. For example, the following revenue recognition types are common: 

  • Sales Basis Method: Revenue is recognised at the time of sale or delivery of the product or service.
  • Installment method for revenue recognition: Income is recognised according to the instalment method.
  • Percentage of completion: Revenue is recognised by reference to the stage of completion.
  • Completed contract method: In the case of long-term contracts, revenues are only recognised upon completion of the respective project.

But which method should be used? Companies need to choose the right method to ensure that their accounting meets the requirements of accounting standards and legal regulations. 

What is the Revenue Recognition Principle?

According to the so-called revenue recognition principle, companies realise earnings when they have delivered products or rendered services to their customers. The realisation does not take place at the time of the payment transaction, but when the service is rendered. 

Revenue Recognition for SaaS Accounting

Example: Assuming that 120 euros plus VAT are due directly upon conclusion of a SaaS contract, but the user can use the software for one year, the question arises as to how the 120 euros are to be booked. The SaaS company has not yet (fully) provided the service at the time of payment by the user. What happens if the customer decides to change the package after 6 months? Or if the customer cancels the contract after 10 days? So the question of revenue recognition is not so simple here. 

 

In the case of subscription business models, such as SaaS, this means that the proceeds must be distributed ratably over the (planned) contract term. This also applies if the fee has to be paid before or at the beginning of the contract term. 

 

Note: Important data is provided by contract management. Conditions, for example, provide a lot of information that has to be processed in accounting. But without modern technologies, the data can hardly be processed correctly and promptly. Therefore, especially SaaS providers need a software solution here that also covers the revenue recognition processes.

 

How does revenue recognition work?

The accounting standard IFRS 15 provides a 5-step model for determining the amount and timing of revenue: 

 

  • Step 1: Identify the contract(s) with a customer.
  • Step 2: Identify the stand-alone performance obligations in the contract.
  • Step 3: Determine the transaction price
  • Step 4: Allocation of the transaction price to the performance obligations in the contract
  • Step 5: Revenue recognition when the entity fulfils the service obligations.

 

The basis for correct recognition should already be laid in the billing system. With billwerk, not only invoicing is automated. The billwerk software solution supports turnover recognition methods. Deferred charges and accrued income can also be easily formed on the basis of reliable data. Detailed evaluations show how subscriptions and turnover develop. Business growth can be controlled in a targeted manner in this way.

Best Practices for Revenue Recognition

  1. Compliance requirements must be adhered to! Companies should be aware of the accounting standards (IFRS 15 / ASC 606) and implement them properly.
  2. Subscription providers should use a software solution that facilitates revenue recognition. In this way, accounting processes can be optimised and made IFRS-compliant.
  3. The software solution should implement the 5-step model (IFRS 15) automatically, so that the accounting department is relieved and human errors are reduced.
  4. Those who understand the revenue recognition principle can better align their own business model and optimise their own set of figures. The accounting department can thus provide the critical data to lead the subscription business to more growth.
  5. Revenue recognition brings with it the difficulty that turnover detection and cash flow development are not necessarily identical. The controlling department must be sensitised accordingly.

 

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How to use revenue recognition effectively for your subscription business
Generating revenue is essential for any business. But especially in the subscription business, revenue recognition is a big challenge and requires a clear strategy. What is it all about? And what makes the topic so important for subscription business models? Here is a brief overview:

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