Three numbers, three meanings
You read three numbers about the same customer, and they disagree with each other. The sales deck says the customer is worth 120,000 a year, the billing report says you invoiced them 120,000 in January, and the P&L for the first quarter shows 30,000 of revenue from them. All three numbers are correct; they simply answer different questions.
The first is recurring value, meaning the annual total of the invoices that repeat. The second is what was billed, and the third is what was earned. This article walks through why the three numbers differ, using a single invoice for a single customer.
Recurring value is a forecast
Annual recurring value, usually called ARR, is the yearly value of the invoices that repeat. It is a useful number for a board or an investor, because it indicates how large the business is if every customer continues. But it is a forecast rather than a record, and nothing in the financial statements ties to it. It counts a customer who might cancel next month at a full year, it excludes the one-off work you also billed, and it says nothing about which period the money belongs to.
Ressura never states an ARR figure unprompted, and no finding carries one. When it refers to recurring value at all, it means the total of the invoices that repeat, read directly from those invoices in your books, and nothing more.
What you invoiced is what you billed
Consider the one invoice: on 5 January you send a customer an invoice for 120,000, covering a subscription that runs from January to December. Billed for the year: 120,000. That figure is a fact, and the invoice is the document that establishes it.
But on 5 January the customer has not received a year of service; they have received none of it. An invoice is a promise to deliver and a request for payment, not the delivery itself.
What the P&L shows is what you earned
Revenue is counted as you deliver the service, not when you issue the invoice. Accountants call this recognising revenue, and it is the one accounting word in this article. The rule behind it is simple: a month of service delivered is a month of revenue earned.
By the end of March you have delivered three months of a twelve-month subscription. Earned: 30,000. The remaining 90,000 has been billed but not yet delivered, and that amount is owed to customers, not in cash but in service. If the customer walked away in April, nine months of what you billed them would still be yours to deliver.
Here is the same invoice as three lines at the end of March:
- Billed: 120,000
- Earned: 30,000
- Owed to customers: 90,000
The 90,000 is a genuine balance. It appears on the balance sheet as an obligation to the customer until you deliver it, one month at a time, and it belongs beside the revenue figure in every board pack.
Where the numbers go wrong
Many growing companies record the whole invoice as revenue in the month they send it. January looks like a remarkable month, February and March look empty, and the year comes out right in the end. But every month along the way is misstated, and so is any quarter a board reads; move one invoice date by a week and a whole quarter changes.
An auditor looks for this first, because it is the most common revenue error, and a lender reading a covenant or an acquirer's accountant will discover it too. The remedy is not complicated. Allocate each invoice across the months it pays for, and maintain a schedule of what is still owed to customers at the end of every period. The schedule is what the auditor, the lender and the acquirer will each request, in that order, and it is the same schedule every time.
The check that catches it
Ressura tests this invoice by invoice, in the Order-to-Cash module, against the agreement behind each customer. Earned against billed compares what an invoice billed with what should have been earned by the end of the period, given the months the agreement says the invoice pays for. When a company records the whole invoice as revenue on the day it is issued, the finding says so in plain words and identifies the months the invoice overstates.
Owed to customers reports the balance still to be delivered at the end of the period, invoice by invoice, with the agreement and the invoice behind each number. Where there is no agreement, the finding rests on what you tell Ressura about the term, and identifies that as its source.
That is the difference between the three numbers, and the check that measures it. Read what Order-to-Cash checks.