Revenue recognition vs revenue reconciliation: What are the differences?

What is revenue recognition?

Revenue recognition is the exact point when cash becomes revenue, i.e. when the service is completed and delivered. 

In SaaS, that’s typically when the customer is granted access to your service.

But as your business grows and becomes more complex, it becomes less clear when exactly you should recognize revenue. 

For example, imagine handling 1,000 clients every month, with a whole host of upgrades, downgrades and other complexities – each needing to be recognized.

During the sales process, revenue could potentially be recognized at many different points. So it’s necessary to define a precise point when cash becomes revenue. 

That’s where the revenue recognition accounting principle comes in. It’s a key part of accrual accounting, stating that cash is only considered revenue once the product or service has been delivered in full. At that moment, the amount gets recorded in your account receivables. 

But until that point is reached, the customer may still ask for a refund. If the money has already been spent, you risk creating major issues with your accounts. 

Deferred revenue is an advance payment that a company receives in return for services to be performed in the future. 

For example, with an annual subscription, the revenue can only be recognized month-by-month. The remainder is classed as deferred revenue. 

In May 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) created Accounting Standards Codification 606 (ASC 606). Their aim was to provide a simple, industry-agnostic framework for recognizing revenue. 

ASC 606 consists of a five-step model – all necessary to satisfy the revenue recognition principle:

1. Identify the contract with the customer.
2. Identify contractual performance obligations.
3. Determine the amount of consideration/price for the transaction.
4. Allocate the determined amount of consideration/price to the contractual obligations.
5. Recognize revenue when the performing party satisfies the performance obligation.

International Financial Reporting Standards (IFRS) 15 is a more recent, international set of standards for revenue recognition, but it follows the same five-step model as ASC 606. (Read more on IFRS 15 here).

How does an MoR help with revenue recognition?

A merchant of record (MoR) is the legal entity selling goods or services to an end customer. 

The MoR handles all payments and takes on the liability related to each transaction, so your business doesn’t have to. 

Using an MoR that’s purpose-built for SaaS, such as Paddle, helps with revenue recognition by providing you with a clear picture of every dollar coming into your company – all in one handy dashboard.

What is revenue reconciliation?

While revenue recognition is a principle governing when cash becomes revenue, revenue reconciliation is the process of reconciling all completed sales with all cash received during a given period (also known as ‘closing the books’). Revenue reconciliation is critical to make sure your top-line financials are accurately reported.

How does an MoR help with revenue reconciliation?

The key benefit of using a SaaS-centric MoR for revenue reconciliation is having all your firm’s revenue streams easily accessible in one unified dashboard. 

This ‘single source of truth’ is invaluable for ensuring the best possible accuracy and efficiency in the revenue reconciliation process. 

Added bonus – using an MoR lightens your admin load, as you’ll only have one set of payouts (those from the MoR) to add to your books.

Why accurate revenue recognition and reconciliation matter for SaaS

For SaaS firms, accurate revenue recognition and reconciliation are mission-critical in many areas of business. 

One area where this is especially important is when undergoing due diligence for your next funding round. 

Investors want to see solid evidence of your firm’s compliance with accounting standards, typically in the form of automated recognition rather than manually in an Excel spreadsheet. 

Not only does this show operational efficiency in proving your revenue, it also shows a process less prone to human error.  

What’s more, accuracy in revenue recognition and reconciliation helps potential investors clearly understand the true story of how your business has grown.  

In general, but especially when seeking funding, it’s vital to keep your billing processes as simple as possible, so it’s easier to prove and recognize revenue. 

Keeping billing simple gets harder as your SaaS grows. Having automated processes in place early on is a smart way to prepare for the future.