Tech company revenues – so important for valuations as these companies aim to build and grow. The sector has long used revenue multiples, and not traditional profitability measures, to justify valuations. But what, and here’s the rub, exactly are revenues under accounting standards?
Tech companies will usually earn revenues under contract with customers through the following basic forms:
- Building and onboarding customers onto a platform, together with any initial outlay of software or hardware tailored to the customer
- Licensing to those customers over the period of contract, and
- Managing a helpdesk or customer support function throughout the duration of the contract.
Typically, these contracts are structured in a way that allows such revenues to be invoiced in advance. For example, licensing fees are invoiced at the inception of the licensing period. However, under accounting standards, this is not necessarily revenue, even if those charges don’t allow for customer refund.
Under International Financial Reporting Standard 15 (IFRS 15), such tech company revenues are recognised over the period that the customer separately benefits from the service. Therefore, revenues obviously connected with licence streams are typically deferred and amortised over the life of the contract.
The one that stings, just a little, are those platform or onboarding charges – there is a logic here that the work is done, so why not bill it? Unfortunately, at the onboarding stage, it usually is difficult to justify how a customer can separately benefit from such services. The onboarding or platforming work is typically intrinsically linked to the benefit that the customer receives over the term of the attaching licence agreement. They are normally unable to benefit from such work by, for instance, on-selling such platforming / onboarding work to another party. The result is that these charges, as well as the customer support charges, should be deferred also and recognised over the contract, together with the licensing fees.
I have sold you the bad news, however, there is scope in IFRS 15 to assuage the pain such enterprises will experience in deferring these revenues to the profit and loss and balance sheets. Any incremental costs to contract directly linked to the revenue can also be deferred and amortised in the same way as the underlying revenues. The trick to this is ensuring that such costs can be directly linked to such revenue streams – it is difficult to prove this with an overhead / administrative allocation.
A useful mantra with such revenues is if in doubt – defer. Yes, there is a short-term painful hit from doing this, but it’s much better for the enterprise to go through this exercise than to wait for the inevitable pain that will hit in either a sale, seed round or IPO due diligence process. You will also strengthen the credibility of the underlying rigour of your accounting systems and processes in so doing. And, you’ll have much greater clarity around what exactly are your revenues for regulatory purposes, including:
- Grant thresholds, typically for research and development tax offsets
- Early-stage innovation company tax thresholds, and
- Revenues required for acquittal reporting to public and private donors / benefactors.
Smart CFOs recognise that getting tech company revenues right in this context has significant importance and they will liaise with their accountant and/or auditor to build revenue deferral models that meet the exacting requirements of IFRS 15.
For more on understanding tech company revenues, contact your local William Buck Audit and Assurance Advisor.