Show Me the Money! Revenue Recognition Best Practices (Part 1 of 2)
I bet that made your ears perk up a bit, didn’t it?
Your CFO probably has the same type of reaction when the topic of revenue recognition rears its head. After all, it is one of the most critical elements in your business’ machinery.
Customers frequently ask me about the impact license enforcement and license key delivery can have on a company’s ability to recognize revenue. This indeed can be a touchy subject, so I should start by making a few foundational statements.
I will not suggest how your company should manage revenue recognition nor do I intend claim the revenue recognition practices are acceptable or VSOE compliant. Your company’s finance team should be the ultimate authority as to what is acceptable for your business. I encourage any business considering license enforcement to ensure your CFO is will deeply engaged in your license delivery processes.
I will, however, discuss a number of revenue recognition techniques and best practices that I have seen used by multiple successful companies with revenues over a half billion per year. When Should Revenue Recognition Occur?
It is common for many companies to recognize software license revenue when they can prove that they have given the customer “access to the software”. The tricky part of the equation is the word “access” is subjective and can be open to interpretation.
It is fairly straight forward when your company needs to ship its software with physical media (CDs, DVDs, etc) or ship license keys using hardware dongles. In these cases, the company will typically recognize the revenue when the shipment has left the building.
Things get much more interesting with electronic delivery of software and licenses. As a software vendor, here are a couple questions you should ask yourselves:
- If I deliver my software via my download site, do I need to prove the customer downloaded the product before I can recognize the revenue?
- If my software needs a license key or needs to be activated in order to run, do I need to prove the customer received the key or activated the software?
From these answers, you’ll have the framework for defining your revenue recognition process. But, there are still a few more considerations.
Revenue Recognition: Does Notification of Access Trigger Receipt?
While some companies feel safer recognizing revenue only when the customer has actually received their software delivery (either electronically or physically) and have received their license key, many companies recognize software license revenue when the customer is notified how to download the software and how to either get their key or activate the software.
An efficient way to do this will be to have a back-office system automatically send email to one or more customer contacts on the software order. The email notification will contain guidance for procuring the software and getting their license key. The business can then consider this action as giving the customer access to the software.
The figure below shows a common configuration of a back-office system with electronic license enforcement in the mix. Orders get entered into the ISV’s ERP system at the top which are commonly integrated with a customer database (middle left), some sort of a license key generation tool (middle center) and will also flow into a software fulfillment system (middle right).
In most cases, it is common to either have the ERP or the license generation tool send the email notification that will tell the customer how to get their software and license keys. It is at this point where many companies recognize revenue as they can prove the customer has been given “access to the software”. Since the system sends the email to the customer within minutes or seconds of order entry, many companies recognize the revenue immediately and without any human interaction.
There is, however, another key element we need to bring into the revenue recognition equation: Time. Time can affect revenue recognition in a few ways.
- We have the time required by the customer to actually get their license keys after the ISVs claims to have given them “access” to the software.
- We have the software’s ability to run by default without a license key for a temporary amount of time. Does that count as “access”?
- We have some ISVs selling perpetual entitlements but wanting or needing to deliver license keys that expire annually. Does the customer really have access to what they bought?
Stay tuned. We will look at the time factor in my next blog.