Visibility Into Future Revenue Streams: You Can Throw Out The Crystal Ball and The Ouija Board, There's a Real System For This

- RevenueRecognition.com

The difficulty of on-target, data-supported revenue forecasting is nothing new. Many factors have traditionally played into the complicated, often arduous task of selecting targets that are realistic, yet in line with the expectations of involved parties such as shareholders. But what often makes or breaks an executive team's ability to predict, with confidence, what the future holds for their company in financial terms, is the ability to control the entire revenue management process. Many companies lack the robust, multi-faceted systems that are necessary to manage contracts; allocate, defer and recognize revenue; comply with stringent SEC and FASB regulations and guidelines; and ensure consistency in accounting practices in this mission-critical area.

The best examples of the challenges inherent in proper revenue management processes are found in the high-tech industries. Current software, content and Internet companies in particular operate with rapidly-evolving business models involving multiple revenue streams from complex contractual structures. They must manage a combination of license, subscription, maintenance and product offerings, along with their related delivery dates over phased schedules, and therefore numerous, often overlapping billing cycles. There is a tangible, quantifiable benefit with the implementation of automated processes that deliver not only more timely revenue, positively impacting cash flow, but also standardize the reporting capabilities of the operation. And consistent reports based on sophisticated methods of revenue management are the key to the most accurate forecasting possible.

When an organization is unable to clearly separate and identify the revenue streams that sustain their business, they're almost guaranteed to be losing revenue. The likelihood of increasing their operating costs, and hampering vital cash flow, is extremely high as well. In this kind of situation, the core of the business is self-limiting, unable to scale as the company grows, and suffers from a highly inefficient use of employee time and skills. Any benefits of economies of scale are simply unobtainable for these companies. But the most worrisome factor in this picture is the extreme risk for error and negative exposure. The SEC can force an inquiry and subsequent revenue restatements, which can cost a staggering amount of money and ruin a business in a matter of months.

So why is it that so many corporations still employ a mix of accounting systems, financial packages and manual spreadsheets to handle, track and report revenue? If visibility into future revenue streams and options for growth is so essential, why is it so difficult to obtain?

Part of the answer lies in the rapidity with which today's business models have both arisen, and have morphed into increasingly more complex versions of themselves. To take full advantage of market entry windows and emerging market segments, the requirement to constantly adapt processes and business practices is a daunting challenge. And while financial and accounting systems have been around for a long time, specialized revenue management solutions are relatively new. Oftentimes the ROI and long-term value of these solutions is simply not known to the very executives who could most benefit from using them.

There are several ways in which revenue management methodology can ensure a high level of accuracy and ease-of-process in this functional area. For one, revenue management systems, when used to their full functionality, will easily identify for executives each and every channel through which revenue flows. This is for past, present and future revenue-especially valuable for those multi-component, high-tech contracts that involve revenue allocation and billing schedules, as well as deferred revenue percentages based on the FASBs SOP 97-2 and 98-9 guidelines, and the SEC's SAB 101/ SAB 104. For an explanation of these in detail, please refer to the text at the end of this article.

Second, companies with numerous business entities, product/service bundles, or other organizational elements, revenue management system reporting will delineate clearly which business areas are healthy, generating revenue as expected or needed, or are under performing. Separating out each revenue generator enables a company to make decisions based upon each unit's performance, so business areas can be classified according to maturity in lifecycle, fit with current market conditions, and revenue potential, and then dealt with individually.

Third, a solid, defensible, data-based and highly quantifiable look into future revenue streams -according to received contracts, not just projected business activity-provides the tools that drive future corporate actions. This unique visibility into what is certain about short-term financial results, rather than guessed, serves to isolate what is known, from what can be projected. This reduces the reliance on market research to push executive decision-making, and makes the task of estimating future profitability more contained in scope. It also reduces risk.

Finally, carefully orchestrated business productivity can be implemented and tracked as often as necessary. This allows for daily monitoring and analysis of a company's true financial and organizational health, rather than an end-of-quarter scramble to produce reporting that meets both goals, and in some cases, requirements.

The conclusion is clear, and infinitely logical. Revenue management systems are the single most enabling element in accurate forecasting. It's this author's prediction that in a few short years, their use will become a standard part of every US-based business.

Addendum: SEC and FASB Regulations and Guidelines
For these organizations, the existence of increasingly more stringent SEC and FASB guidances and regulations that address proper revenue recognition demand extreme vigilance, and daily adherence. SOP("Statement of Position") 97-2 and SOP 98-9, and SAB ("Staff Accounting Bulletin") 101/ SAB 104 are the recent regulations that high-tech operations must comply with. If a company's current revenue management processes are incomplete, or non-standardized, there's a good chance the company using them is leaving themselves open to significant error, like botched billing opportunities that result in uncollected revenue at the right time; or in another area and worse, misstated and misallocated revenue. This complicates the quarter and year-end financial closing process, and consumes valuable man-hours that could be used for something else had the systems and procedures been automated, with sophisticated methods of identifying and eliminating errors, and more importantly, those transactions and allocations that violate FASB's 97-2 and 98-9, and the SEC's SAB 101/ SAB 104.

FASB's SOP 97-2, introduced in 1997, was intended for application to the software industry. It recognized the multi-element nature of most software business contracts with their customers, and in simplified layman's terms was meant to ensure that companies booked revenue not on orders, but on shipped, and fully received, contractual elements. This involved separating license, maintenance, services and product revenue from each other and accounting for each in detail over phased allocation schedules. It also required that documental evidence of a business arrangement exist, like a signed contract, to support the individual contract management and its related schedules of invoicing and recognizing revenue. In addition, charges associated with the contract need to have fixed or determinable fees. Other stipulations involved allocating revenue using VSOE, or vendor specific objective evidence, like a price book that delineates component pricing when sold separately, and prices set by management with appropriate authority. If no VSOE is present, SOP 97-2 requires that the entire contract be deferred, causing immediate impact to a company's bottom line. Without properly applying these methods to book-keeping, it is near impossible to understand future revenue bookings, and the true financial position of any company.

SOP 98-9, issued by FASB in 1998, was an extension of the principles inherent in 97-2. Recognizing the complexity of multi-component contracts even more, it put forth the term "residual method" for situations when VSOE for undelivered contractual elements exists, but VSOE for delivered elements does not exist, and all other revenue recognition criteria has been satisfactorily met.

The SEC examined 97-2 with an eye towards making it broadly applicable to all industries, high tech or otherwise. It issued SAB 101/ SAB 104, which, to summarize, said that as of the fourth fiscal quarter of fiscal years beginning after 12.15.99, it became mandatory for all public companies in the USA to hold to SOP 97-2-like accounting standards - obviously, modified to be appropriate for businesses such as manufacturing operations. Whether or not this exactly fits other business types outside of the high-tech sectors is still a debatable question, but the intent is clear. For those high-tech entities who conduct all of their business within the confines of 97-2, 98-9 and 101/ 104, the struggle is to apply in perfect form the regulations' details, and operate inside the parameters of highly complicated revenue allocation schedules, while still maintaining healthy cash flow from contracts it may take years to fulfill. The temptation to recognize as much revenue as possible up-front is great. Therefore, accurate management reports with hard numbers for revenue projections and forecasts become the lifeblood of any high-tech enterprise. This is the key to side-stepping the revenue management surprises that can unravel a company whose reporting is inaccurate, and whose books are not consistent in methodology.

But the main genesis of SAB 101/ SAB 104 was a marked concern on the part of the SEC about earnings management. In the year 2000, there were 156 earnings restatements; in 1999, 150; and in 1998, 91. The sharp increase was accompanied by shocking market losses. From 1995 to 2000, the loss was $78.3 billion. And in 2000, seven of the top 10 restatements were directly tied to revenue recognition issues. The most celebrated public examples are of Cendant, who restated $11.4 billion, Microstrategy $11.3 billion, and Lucent $10.9 billion. Why the trend? And the losses? Revenue mismanagement, obscured revenue facts, incorrect reporting, and use of pro-forma statements that provide an incomplete picture of a company's actual status.

About the Author
Robert O'Connor is President and Chief Executive Officer of Softrax Corporation. With over 15 years' experience in executive management of software companies, he has proven expertise in finance, sales and marketing. Mr. O'Connor was recognized by Ernst &Young as a finalist for their 2001 Entrepreneur of the Year Award. He is an active member of the ITAA and the Massachusetts Software Council, and a frequent speaker on revenue recognition, business models, and other operational topics. Mr. O'Connor is a graduate of Georgetown University and received his MBA from the University of Connecticut.