How To: Approach Revenue Recognition As A Privately Held Company

For any business, revenue recognition is a critical component of understanding your financial well-being. It can be overwhelming to think about creating revenue recognition policies, especially as a small or midsize business owner with limited resources. But by ensuring your SMB is ASC 606 compliant, or that deviations from ASC 606 compliance are understood, appropriate, and intentional, you will set yourself up for success in the long run – and avoid potential missteps and headaches as you continue to grow.

What Is Revenue Recognition? What Is ASC 606?

Let’s start from the beginning. Revenue recognition is an important Generally Accepted Accounting Principle (GAAP) that directs exactly how and when a business should track and report revenue. This can get complicated when factoring in payment dates vs. service delivery dates, as we’ll dive into later in this article. Accounting Standards Codification Topic 606, commonly referred to as ASC 606, is the official guidance for revenue recognition, as outlined by the Financial Accounting Standards Board. When we talk about a business being ASC 606 compliant, that means the business is following these standards.

Why Is It Important For SMBs To Be ASC 606 Compliant?

While privately held companies (especially SMBs) are not held to the same rigorous financial reporting standards as a publicly-held company, our kept.pro experts have seen firsthand how following ASC 606 principles can positively impact profitability. Information is power. By creating, understanding – and adhering – to ASC 606-compliant revenue recognition policies, you will help ensure you’re receiving accurate and consistent data. This will enable you to:

• Understand if your business is profitable
• See what your liabilities are
• Figure out if your business is liquid and solvent
• Maintain credibility with lenders, investors or other external stakeholders to whom you may report financial information
• Strongly position yourself if you want to sell your business at some point

Without a clear revenue recognition policy, SMBs in particular can open themselves up to:

• Cash flow issues: This happens when fees are collected before products/services are delivered, such as a “mobilization fee” charged by a consulting or construction company. If the advanced fee is recognized when collected, instead of properly accounted for as a liability until earned, it can give the business the impression that they’re profitable when they’re not. Eventually this catches up, usually later in a project when the company realizes they still have delivery obligations (requiring cash outlay), without any corresponding incoming cash related to that project.
• Due diligence issues: This can happen when a prospective buyer conducts a quality of earnings assessment and re-distributes inappropriately recognized revenue. This redistribution can result in a lower valuation.
• Unit economic or quality of decision issues: This happens when a company doesn’t understand which products and/or services are profitable. It can actually be the case that a company is unintentionally (unknowingly) subsidizing a product or service – the more they sell, the more they lose. In order to avoid this, revenue and costs have to be matched up, of which rev rec is a key part.

Small Businesses And Revenue Recognition: Important Considerations

Proper revenue recognition requires your SMB to account for revenue when it’s actually earned (the service is provided), rather than when you receive payment from your customer. Here are seven key factors to consider when creating your revenue recognition policy:

1. Contract details matter. What are you being paid to deliver and how is delivery defined?
2. Timing matters. Be very specific about the period during which you fulfilled your obligation.
3. Cash, tax basis, and accrual basis are each very different. You need to understand cash, as it’s what you use to pay employees and/or purchase inventory. You need to understand what method you use to file your taxes and what the implications of cash- and accrual-based decisions are on your tax burden. You need to understand if you’re profitable on an accrual basis (and manage accordingly). If not, the economic longevity of your business is limited.
4. Right-size your solution. We see it all the time – a small business budget with big business complexity. Try to standardize and streamline operations and policies that directly impact your business administration costs. When in doubt, keep it simple.
5. Document your revenue recognition policy. Clearly outline what is expected, and integrate it with your accounting procedures.
6. Review your General Ledger to ensure it will support your policy. For example, if you will defer unearned revenue, make sure you have a liability account in which to record these deferrals.
7. Review your third party integrations to ensure they’re not recording entries that are inconsistent with your policy. You’d be surprised what can slip through the cracks when you set it and forget it.

Whether you’re a local craft brewery, a marketing agency, a tech company or anything in between, creating clear revenue recognition policies that align with ASC 606 will help you make the best decisions for your business. Getting started can feel a bit daunting – but kept.pro is here to help. Set up a complimentary call with one of our experts today.