What is Unearned Revenue (Deferred Revenue)?
The Short Answer
Unearned Revenue (Deferred Revenue) explained simply
Unearned revenue, also called deferred revenue, is cash a business gets upfront for products or services it will deliver later. Think of it like a deposit. Until the business actually provides what was paid for, that money isn't truly "earned." It sits on the balance sheet as a liability because the business has an obligation to the customer. Once the product is delivered or the service is performed, the unearned revenue moves from a liability to earned revenue on the income statement.
Real-World Example
The Magazine Subscription
Imagine a magazine publisher sells a one-year subscription for $60. The customer pays the full $60 on January 1st. On January 1st, the publisher has $60 in unearned revenue. Each month, as a magazine is delivered, $5 ($60 / 12 months) is recognized as earned revenue. By December 31st, all $60 will have moved from unearned revenue to earned revenue.
Why this matters
Understanding unearned revenue is important for valuing a business because it shows future obligations. A high amount of unearned revenue can indicate strong future sales, but it also means the business has work to do to fulfill those obligations. It helps buyers see the true financial picture and potential future earnings.
When looking at a business, always check how they handle unearned revenue. It can tell you a lot about their cash flow and future commitments. Make sure the business has a clear plan to deliver on those obligations.
When looking at a business, always check how they handle unearned revenue. It can tell you a lot about their cash flow and future commitments. Make sure the business has a clear plan to deliver on those obligations.
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