What is deferred revenue?
Deferred or unearned revenue is money received by a company for goods or services that have not yet been provided. It is considered a liability because it represents an obligation to deliver a product or service in the future. Only when the product has been shipped or the service has been performed does deferred revenue transition to earned revenue.
Deferred revenue appears on the balance sheet under current liabilities if the goods or services are expected to be delivered within a year, and as long-term liabilities if the delivery timeframe extends beyond a year. As the company fulfills its obligation to deliver goods or services, the deferred revenue is recognized as earned revenue on the income statement, reflecting the true income generated in that period.
Deferred revenue is prevalent in businesses where payment precedes service delivery or product shipment. Subscription-based models, such as software-as-a-service (SaaS) companies, often report significant deferred revenue because they collect subscription fees upfront for a service that is delivered over the subscription period.
How to use
The Standard Financial Model, Starter Financial Model, and Runway Budgeting Tool all share a core component in the Forecast sheet that handles the calculations of deferred revenues using a standard corkscrew build.
In the core revenue and expense section on the Forecast sheet, any line can be assigned to Revenues or Billings - revenues represents recognized revenues, billings represents what customers are billed - and the sum of all of the revenues and billings lines are used to calculate deferred revenues. Billings increases deferred revenues, recognized revenues decreases deferred revenues.
How it works
Deferred revenues will appear whenever you use the revenues settings on Get Started to create contracts where the months billed upfront is greater than one. For example, if you bill for an annual contract upfront in January - say $100 a month, or $1200 for the total contract - then you will have 1,200 in billings in January, 100 in revenues in January, and you will recognize 100 each month throughout the year.
The model will automatically adjust the financial statements to account for deferred revenue liability on the balance sheet, and calculate the impact on working capital on the statement of cash flows. As a note, while normal accounting for deferred revenue would separate it into long-term (deferred revenues due to be recognized in greater than one year) and short-term (less than one year), the Foresight models simplifies it to one deferred revenues liability without separating it into short-term and long-term components.
Note that when cash is received is separate from billings, and that comes from the accounts receivable assumptions for how long it takes to collect on invoices when they are billed, and the model has a separate core component for accounts receivable.
Why is deferred revenue growing in my model?
A common quesion with an easy fix. Any time you add a revenue stream to the model, the best practice is to to add a line for the billings for those revenues. The model has a default assumption on Get Started for automatic revenue recognition that will calculate billings if no lines for billings are present, but it is a beset practice to add a line for billings yourself. If you add a revenue stream and see deferred revenue growing and you aren't expecting to have deferred revenues, it is because you need to add a line of billings.
It's easy to add that in if billings is equal to revenues, e.g. a month-to-month subscription that is billed monthly, or ecommerce businesses when orders are billed and delivered in the same month. It's a bit harder for contracts that span multiple months; that functionality is prebuilt into the Standard Financial Model, and can be added custom in the Starter Financial Model and Runway Budgeting Tool.
Dealing with existing deferred revenues
If you have existing deferred revenue coming in from the opening balance sheet you inputted on the Statements sheet, the model will make an attempt to forecast how to recognize revenues from it, but you will often want to add in a new line in the primary revenue and expense build on Forecast to model the them discretely.
Using a custom revenue model or a forecasting tool
If you are linking in the SaaS Forecasting Tool or any custom revenue model, you will want to link in the Revenues and Billings line from the modeling being added in; it is not necessary to link in any deferred revenue calculation as the models with this component will do that automatically.