A company invoices $90,000 in January, collects $75,000, and recognizes $70,000 in revenue.
Three perfectly reasonable numbers.
Three different financial statements.
And, apparently, three opportunities for the forecast to go wrong.
This happens frequently in businesses that bill customers before delivering the associated products or services. Subscription contracts, annual maintenance agreements, prepaid service arrangements, and implementation projects can all create differences between invoicing, cash collection, and revenue recognition.
The solution is a deferred revenue roll-forward that connects the income statement, balance sheet, and cash forecast.
The basic formula is:
Ending deferred revenue = Beginning deferred revenue + New deferred billings − Revenue recognized from deferred balances
That formula works for a simplified model in which all new billings initially create contract liabilities and there are no refunds, contract modifications, or other adjustments.
The accounting can become more complicated. The underlying forecasting discipline shouldn’t.
First, Separate Revenue, Billings, and Cash
Suppose a company sells a $120,000 annual service contract.
The customer receives twelve months of service and is invoiced upfront.
Assume the contract is noncancellable, the invoice creates an unconditional right to payment, the service is a single performance obligation satisfied evenly over the year, and there are no unusual revenue recognition provisions.
Under those assumptions:
- Billings: $120,000 when invoiced
- Revenue: $10,000 per month as the service is delivered
- Cash: Recognized when the customer actually pays
The invoice doesn’t create $120,000 of immediate revenue.
It establishes a receivable and a contract liability.
The contract liability represents the company’s remaining obligation to provide services for which payment has been received or is due.
As the company delivers the service, it recognizes revenue and reduces that liability.
This distinction follows the revenue recognition principles in ASC 606.
For FP&A, the consequence is straightforward: billing activity cannot substitute for a revenue recognition schedule.
Build a Three-Month Deferred Revenue Forecast
Consider a hypothetical service business entering January with $120,000 in deferred revenue.
That opening balance relates to contracts already invoiced in prior periods.
The company expects to recognize $40,000 per month from those existing contracts during January, February, and March.
It also expects three new annual service contracts, invoiced upfront, with service beginning in the invoice month.
| Contract group | January revenue | February revenue | March revenue |
|---|---|---|---|
| Opening deferred revenue | $40,000 | $40,000 | $40,000 |
| January contract: $90,000 | $7,500 | $7,500 | $7,500 |
| February contract: $60,000 | — | $5,000 | $5,000 |
| March contract: $30,000 | — | — | $2,500 |
| Total revenue | $47,500 | $60,000 | $55,000 |
Each new contract covers twelve months of service.
The monthly recognition amounts are therefore:
January contract: $90,000 ÷ 12 = $7,500
February contract: $60,000 ÷ 12 = $5,000
March contract: $30,000 ÷ 12 = $2,500
The revenue forecast follows the delivery schedule, not the invoice schedule.
Notice what happens in March.
The company invoices only $30,000 in new business but recognizes $55,000 in revenue.
That doesn’t necessarily indicate a problem.