Glossary
Revenue recognition
Revenue recognition is the accounting principle that determines when revenue is recorded in a business's financial statements. For agencies, this is particularly important because project revenue is earned over time, not necessarily when invoices are issued or when cash is received. Proper revenue recognition gives an accurate view of financial performance in any given period.
Why revenue recognition matters for agencies
An agency might invoice a client for 50% of a project fee upfront, but if only 20% of the work has been completed, only 20% of the revenue has been earned. If the full invoice amount is recognised on receipt, the agency appears more profitable in the short term than it is, which distorts financial planning and tax calculations.
For agencies with multiple active projects at different stages of completion, the difference between cash-received revenue and recognised revenue can be significant.
Percentage of completion method
The most common approach for service agencies is the percentage-of-completion method. Revenue is recognised in proportion to how much of the project work has been completed. If a £100,000 project is 40% complete, £40,000 of revenue is recognised in the current period, regardless of invoicing status.
Completion percentage can be measured by hours logged versus hours budgeted, by milestones achieved, or by cost incurred versus total estimated cost.
Deferred revenue and accrued revenue
When a client pays in advance for work not yet completed, that cash is deferred revenue (a liability) until the work is done. When work is completed but not yet invoiced, the earned but not yet billed amount is accrued revenue (an asset). Both are important balance sheet items for agencies with significant project work.
Example
An agency signs a £120,000 annual retainer, invoiced quarterly. At the end of Q1, £30,000 has been invoiced and received. But the agency has only delivered 8% of the annual work programme. Recognised revenue is £9,600 (8% of £120,000). The remainder of the £30,000 received is deferred revenue on the balance sheet.