- March 1, 2011
- Posted by: afr
- Category: AFR First Thoughts
Deferred revenue is the cash you collect in one fiscal cycle that is related to, and in support of, a future fiscal cycle. As such, it can pose a significant (and dangerous) temptation.
Let’s say you’ve met your revenue goals for the current year, and now you’re selling promises to provide services the following year. Cash is getting tight, so you dip into next year’s cash to pay for current operating costs. It seems like everyone does it from time to time. However, it can’t be overemphasized that this practice should not be conducted casually.
Does your org’s Balance Sheet reflect deferred revenue in an amount that’s significantly higher than your current operating cash balance? If so, that variance represents dollars being borrowed from next year’s programs to pay for this year’s costs. If steps aren’t taken to control that situation, you’ll likely borrow again from the following year to pay for next year’s costs. And on and on.
It could be argued that it doesn’t really matter. All the bills are being paid each year, what does it matter if we’re paying for them with money from this year or next?
That argument works just fine, until you consider that the practice places an increasing amount of pressure on your revenue performance; each year needs to be as strong or stronger than the year before. You know your expense budgets aren’t likely to be shrinking anytime soon.
And then the unexpected. Maybe you find yourself falling short of generating that revenue for the next year. You’ll still have the obligation to provide services, but with a dwindling balance of cash in the bank to provide them, and not as much cash from next year coming in to bail out your org. Quality of services could be impacted, revenue collection could become more challenged, and a very dangerous spiral can be created.
Granted, this is all hypothetical, and perhaps a shade dramatic. But this scenario is designed simply to demonstrate one reason why it’s a good idea to be a little extra careful when you begin borrowing from the future to pay for the present.
Keep your orgs cash healthy, and drop me a note if you have questions!