There are two vital parts to a successful month-end close (especially for startups and SaaS companies): Revenue recognition and revenue reconciliation.
Many startups make the mistake of focusing on recognizing and recording transactions, skipping the reconciliation process — a crucial accounting step.
We’ll discuss the basics of revenue recognition and reconciliation, what they are, why they’re essential for your business, and how to get started.
Related: Accounting for Startups
What Is Revenue Recognition?
Revenue recognition is a fundamental concept in accounting that determines the timing and process by which you record and recognize revenue as an item in your financial statements.
The principle of revenue recognition states that you should only realize revenue once you deliver the goods or services that a person or business purchased from your company.
As your business grows, this process becomes more complex; however, understanding where you earned your revenue is relatively straightforward for most startups. From here, let’s move on to defining revenue reconciliation.
What Is Revenue Reconciliation?
Revenue reconciliation is a crucial part of your month-end close process; it ensures that your top-line financials are accurate. Reconciling your revenue means reconciling your sales — goods delivered, services provided, etc. — and cash received over a certain period.
The point of revenue reconciliation is determining what you need to record on your balance sheet and income statement. You can also use it to help calculate your cost of goods sold and gross margin for the associated revenue.
Cash vs. Revenue
Because so many startups are in the SaaS space, there’s an essential aspect that many don’t think about: Cash isn’t revenue — particularly for SaaS companies.
This concept might seem difficult to many startups, but here’s an easy way to think about it: No matter when your customer’s cash arrives in your account, you can’t count it as revenue until you deliver the product or service that the customer paid for.
But why does this matter for revenue reconciliation?
Before that cash becomes revenue, it should remain in your account as deferred revenue — until you deliver that product or service, your customers can ask for that cash back at any time.
While this difference isn’t as crucial for companies that deliver a product immediately upon payment (like brick-and-mortar retail stores), many businesses must understand the difference between cash and revenue for accounting purposes.
Wow — that can be confusing. And so can taxes. Click here to see if you missed filing for any beneficial tax incentives.
The Importance of Revenue Reconciliation
The best way to understand why revenue reconciliation is crucial is by looking at what happens if a business doesn’t reconcile its revenue — let’s explore the short- and long-term effects of not performing revenue reconciliation.
In the short term, a lack of revenue reconciliation can result in missed invoices and orders and under-collected revenue and cash.
In the long term, ignoring revenue reconciliation can lead to the inability of a business to look at its financials and project future cash flows accurately.
A well-controlled revenue reconciliation system allows businesses and startups to access accurate top-line financials, providing benefits like:
- Gaining a true understanding of their margins, growth, and revenue
- Reporting more accurately to investors and key stakeholders
- Accessing an accurate balance sheet and financial snapshot
Related: What Is the WOTC?
How to Perform Revenue Reconciliation
Revenue reconciliation starts with your month-end close — a core accounting function that gives you a look into your monthly financials. Managers, lenders, investors, and other stakeholders will all want to see your month-end close documents. Remember that recording your transactions is only the first step.
This process involves two key parts: Revenue recognition and account reconciliation.
Account reconciliation is similar to revenue reconciliation; however, it covers a broader range of topics — it’s the process of comparing two sets of records to ensure the numbers match.
We won’t go too deep into account reconciliation in this article, but keep two key points in mind:
- Account reconciliation is a process to ensure that cash inflows and outflows always correspond.
- The process involved reviewing every individual transaction to ensure the amount captured matches the amount spent.
And the five steps of account reconciliation include:
- Comparing bank statements against cash book statements
- Documenting payment records that show up in your cash book but not your bank statement
- Looking for any inconsistencies between transactions that are in both your cash book and bank statement
- Checking your bank statement for errors (and reporting them)
- Ensuring the balance of both documents is equal.
How to Successfully Reconcile Revenue
So we know that recognition happens when you book a transaction to an account, and reconciliation shows that you recognized it correctly — what comes next?
Successful revenue reconciliation relies on your business’s ability to tie relevant general ledger accounts to their source data. This process typically consists of four steps:
- Record all of your cash transactions (remember not to count the cash that is currently deferred revenue).
- Reconcile your sales data to those cash transactions
- Record your revenue entries using that reconciled sales data
- Reconcile your ending revenue balance sheets (deferred revenue, accounts receivable, and funds in transit or clearing accounts).
Your monthly revenue reconciliation process should involve recording every transaction and then proving each balance sheet account.
It’s a time- and labor-intensive process, particularly for startups where the founders are doing most of the work, but it’s a necessary one.
Revenue reconciliation, accounting, and bookkeeping practices can be a challenge — make them easier by browsing our small business resources.
Prepare Your Startup for Revenue Reconciliation
Before starting the revenue reconciliation process each month, whether you’re working with an accountant or doing it yourself, you’ll need to gather a few things, including lists of your:
- Bank accounts
- Payment processors
- Credit cards
- Other financial accounts
And depending on your business model, you may need access to other things, like your order management systems, contract databases, fulfillment systems, etc.
Combining the data from each of these places will help give you a deeper understanding of your business and establish better monthly accounting processes.
Related: How to Get Started Bookkeeping