Four common revenue recognition examples
We get it—wrapping your head around all of this can be confusing. The easiest way to explain when you should recognize revenue in your own business is by seeing it in action, so let’s look at a few revenue recognition examples.
1. Traditional software companies
Meet Company A, a software company selling an on-prem CRM package for enterprise customers. Instead of running a SaaS product, Company A delivers their software the traditional way - a one-time software package, installed on local hardware run by the customer.
Say Company A releases a new version in January, and the new version costs $10,000 upfront. If a customer purchases and receives the software in January, the company can book the sale and recognize all $10k of the revenue in the same month.
This is the simplest example of revenue recognition. Because the customer takes possession of the software immediately and runs it on their own hardware, the seller can recognize the revenue immediately. Retailers like grocery stores work the same way—revenue is recognized upon delivery, when customers buy their groceries.
Even with this straightforward example, though, it’s still important to recognize the difference between cash and revenue. That difference becomes more apparent in our next example.
2. SaaS companies
Let’s move on to Company B, another CRM software provider who develops a SaaS product. Instead of a one-time charge like Company A, though, Company B charges a $10,000 subscription fee each year for access to their service, and most customers pay for the entire year up front.
Take a look at what happens when a customer signs up for one year on January 16th:
The difference with subscriptions? Company B still has to earn their revenue, even though the customer has already paid for the whole year in advance. Delivery of the service spans the whole year—this means recognizing revenue on a straight-line basis where revenue recognition occurs monthly and the rest is deferred revenue, even though Company B's already seeing an improvement in their cash flow.
The problem with SaaS is that the subscription business model falls between the gaps of GAAP. There aren’t any specific revenue recognition standards for SaaS businesses. This is where a number of SaaS companies trip up—since there aren’t any accounting standards, they fail to realize that they have to recognize the revenue for a service incrementally throughout the time window for that service. If you recognize all the revenue upfront and then spend the cash, if a customer comes to you asking for their money back, you’ll likely find yourself up the proverbial creek without a paddle.
Now, let’s jump out of the software world. Company C sells appliances, and their lack of showroom space means customers often purchase dishwashers, fridges, and other items without being able to accept the products on the spot. Instead, they schedule delivery and installation for a later date.
Say Company C sells an appliance package to a customer on January 16th for $10,000. The customer pays for the appliances on February 10th, but the appliances aren’t delivered until March 3rd. Let’s see how it plays out (you can ignore MRR since renting appliances isn’t common):
Company C should recognize their revenue when items are delivered to the customer, even if paid for in the weeks or months prior. In this specific example, Company C should record the revenue in March—since that’s when the products were delivered—even though the sale was booked in January and paid for in February.
4. Service providers
Our final example comes from the consulting world. Company D is a marketing firm that provides digital marketing solutions to growing startups. Say Company D provides $10,000 in marketing services to one of its clients in January, but the client doesn’t pay for those services until April:
Revenue recognition for service-based work like consulting happens at the time of consulting (when revenue was realized and earned) even if the client pays at a later time. This means Company D should recognize their client revenue in January, even though the cash for those services wasn’t received until April.