The rules of corporate financial accounting generally prevent a company from claiming advance cash payments as revenue. After all, the company hasn't actually earned that money yet. But such payments, known as deferred revenue, still have to appear somewhere in the company's financial statements. Deferred revenue appears on the balance sheet, and the cash flow statement.
In accrual-basis accounting, the accounting method used by all major corporations, a company records revenue when it earns money -- not when it receives money. If it sells good on credit, for example, it books the revenue immediately and collects the payment later. Conversely, if it receives payment in advance, a company doesn't book any revenue until it does everything it's supposed to do in exchange for the money. Until then, the payment is literally unearned revenue, which is also known as deferred revenue.
Deferred Revenue Accounting
Unearned or not, cash received in advance is still cash in the company's hands, and the company needs to account for it. Assume, for example, a company gets a $40,000 cash payment in advance for products to be delivered later. As a result, the company adds $40,000 to the cash total on the assets side of its balance sheet. Then, in recognition of the fact that the company still has an outstanding obligation to earn that money, it adds an offsetting $40,000 under "deferred revenue" on the liabilities side of the balance sheet. Nothing goes on the company's income statement, because the company hasn't actually made any money yet.
Cash Flow Statement
The cash flow statement tracks the cash coming into and going out of a company over the course of a reporting period, such as a quarter or fiscal year. A typical cash flow statement uses as its starting point a company's net income for the period -- its revenues minus its expenses. This figure can be found in the income statement. Because deferred revenue doesn't show up anywhere on the income statement, the company has to add it back in on the cash flow statement.
Major corporations' cash flow statements track the movement of cash in three categories: operating activities, investing activities and financing activities. Deferred revenue usually comes from a company's core operations, and can be found under operating activities. On the statement, you might see a specific entry for something like "Cash received as deferred revenue" or just "deferred revenue." More likely though, the total will be rolled into a broader category such as "Cash received from operations" or "Other operational cash flows." However, if a company received cash as deferred revenue, it will include that cash somewhere on the statement. Smaller companies might not separate their statements into operating, investing and financing categories, but deferred revenue will still be added in somewhere on the statement.
- "Financial Accounting for MBAs," Fourth Edition; Peter Easton, et al; 2010
- Credit Research Foundation; The Trade Creditor's Guide to the Statement of Cash Flows; 1999
- Investopedia: Deferred Revenue