Why revenue recognition matters for subscription businesses
Published: February 15, 2024
Subscription businesses are usually user-friendly when it comes to the flexibility of choice and ease of payment on a monthly or annual basis. But the accounting behind the pricing plans can be a challenge for finance teams.
Enabling the finance team across the subscription journey
A very necessary step to avoid the pitfalls of a complex pricing and product portfolio is a close alignment with the finance team both on a strategic and technical level.
A Bill survey from 2023 (PDF) shows that the majority of finance team leaders feel that they are more and more involved with technology investments and even take on strategic decisions in other departments (e.g., sales). No wonder, since they need to ensure that anything involving finances is fully documented, by the book and can be properly processed to ensure compliance and cash flow.
To avoid spreading finance resources too thin, smooth data processes and automation can ensure that finances are transparent and that manual tasks are reduced (which almost always reduces error rates as well).
In fact, the Bill survey states that AR software (accounts receivable) can have a huge impact on finance teams:
- Better visibility into cash position/cash flow (34%)
- Time savings in processing (34%)
- Easy report creation (29%)
- Better control (27%)
- Reduced processing costs (27%)
- Faster closing books (27%)
- Fewer errors (26%)
- Improved customer relationships (26%)
- Faster payments (26%)
- Reduced late payments (21%)
- Revenue Recognition
Most subscription businesses work with customers paying upfront and then gaining access to services or products over a specific time span (or frequency). This usually results in more complex accounting compared to the usual one-time payment, where a service or product is “exchanged” directly for a payment. The complexity increases when additional one-off costs (e.g. for setup, support, etc.) or various subscription products or services (add-ons, etc.) are added.
Revenue recognition becomes relevant as soon as the time of invoicing and payment and the time or period of service provision diverge (read more here).
Example 1: A merchant writes an invoice ahead of the use of a service for the following year. The customer pays for this time frame. The merchant is now bound to deliver the service over the agreed upon timeframe (12 months). The sales revenue from this invoice are divided over the 12 months. For 12 full months, this means that every single month, 1/12 of the overall revenue is realized.
Example 2: A customer is using a service as part of their subscription. This is being billed after usage. The invoicing of this payment occurs regularly, every first day of the following month. The revenue of this usage will be assigned to the month of usage, no matter the time of the invoice.
The underlying principle of revenue recognition is explained by James from the YouTube channel “Accounting Stuff” in an easily understandable way and in just two minutes.
Another complexity arises when you add bundled services – for example the combination of one-time services or deliveries and services that last over time. For this, the services within this bundle need to be identified and the allocation of each service to the full price needs to be broken down and – depending on the type of service – periodically differentiated. This differs based on the booking standard (e.g., HGB versus IFRS 15), so different approaches to the allocation of the partial revenue on the individual periods could come to fruition.
Subscription Management meets Revenue Recognition
Knowing that revenue recognition can do and knowing about the challenges of complex subscription plans, it’s only logical that any subscription management system can benefit from revenue recognition functionalities that cover different use cases to create data transparency and streamline processes between the subscription and the accounting part of operations.
In fact, with revenue recognition, subscription-based business models have much more clarity on their revenue which also helps forecasting as well as benchmarking to make sure that the company goals can be met.
Billwerk+ supports you with your recurring revenue management, payments and subscription strategy. Set up a demo and get to know our business and our team.
