Revenue Recognition: Revenue – the Elephant in the Room

About Me:

I started my career as a CPA in New York 13 years ago, later working in London and finally now in Istanbul. From big corporates like PwC, to being one of the first hires setting up and automating the operations of a newly formed hedgefund, TPG Axon NY also set up the office for TPG Axon London.

Next moving into venture capital, at Accel, where I discovered my interest in technology and start ups.

In my spare time, I have helped set up the finances and accounting of a non-for-profit art gallery, and consulted start-ups on their financial health, pricing, and accounting.

For fun, I did masters in psychoanalysis, studying people’s behaviours and motivations, and regularly paint.

Now living in Istanbul, I actively participate in the start up and tech world.

I work with 212 helping start-ups establish correct financials and KPIs ranging from analysis to setting up reporting and procedures.

 

Revenue – The Elephant in the Room:

One of the essential KPIs we enjoy ignoring and often record incorrectly is revenue.

Correct revenue collection and revenue recognition are consistent problems in Turkish startups.

When revenue is incorrect, it creates a waterfall of incorrect KPIs leading to wrong decisions.

Saying it in KPI terms, your customer’s long term value will be wrong. The fundamentals to understand LTV (Life Time Value) to CAC (Customer Acquisition Cost) will be wrong.

One consistent issue is recognizing revenue at the time of collection. This is not correct and will misguide our decision-making.

A start up billed and collected 24 months of charges in advance. They booked and collected all 2 years of revenue in the first month. They then used this revenue in all their analysis to understand the product’s viability, their MRR (Monthly Recurring Revenue), set their net years sales goals and expected breakeven point.

Because the revenue was not recorded over the whole 2-year period, it caused them to see the following incorrectly:

  1. The company ignored their long-term responsibility to the customer.
  2. Their sales goals were grossly lower than necessary to reach breakeven.
  3. They positioned their product more as a high volume low cost good instead of what it was – a Software as a Service.
  4. Their sales team expectations were unrealistic. They were focusing on increasing the new customers year on year instead of increasing the monthly reoccurring revenue per customer
  5. Lastly, due to the incorrect long-term view of their revenue, they were not clearly seeing the long term cost expectations for the customer liability for future service to be provided.

An other example is a start up booking estimated revenues as true revenue for each new customer obtaining the service for free.

If you are giving the service for free you cannot book revenue.

Later if a customer does not switch to a fee-paying then the revenue should reflect this accordingly. In this case there was no clear metric reflecting the increase in revenue due to the switch from free to fee paying customer.

This resulted in the start up:

  1. Not being able to switch the free customer to fee paying
  2. Not understanding the need to pivot their product offering since they couldn’t gage the customers’ true value to the product and,
  3. Incorrectly reporting their revenue and EBITDA to investors and other stakeholders.

In these cases, revenue was the elephant in the room that no one wanted to talk about.

Why is it you have a great product or service but no one is willing to pay for it?

If no one wants to pay for it, its not the right product, price or customer.

Don’t ignore revenue.

If you have to ignore revenue there is something wrong with the product or service you are selling.

In art, the monetary value of a painting isn’t related to the skill of the artist nor the brilliance of the art. Value is only set once a collector has recognized it. Before there is a rare valuable painting there must be someone willing to pay for it.

Picasso is only Picasso because the market declares it, not the painter himself.

 

@EzabelArezoo