Bolstering Cash Flow With Strategic Revenue Management

- Robert O'Connor, RevenueRecognition.com

Well-run companies know that their ability to bolster liquidity and improve cash flow is tied specifically to how efficiently and comprehensively they manage their revenues. Revenue management addresses all of the activities that occur across the revenue cycle, from initial contract signing onwards. For many companies in today’s high-tech sectors, the complexities of revenue management create daunting business challenges. Pricing, licensing and billing complexities are formidable. Operationally, confusion over when to recognize revenue, how to allocate revenue over time, and the proper way to process multi-element contracts prevents organizations from fully optimizing their revenue streams. Stringent SEC and FASB (AICPA) guidelines for compliance complicate an already problematic area. In the end, most technology firms find themselves unwillingly handling the revenue management process as a hit or miss endeavor, rather than as the strategic and integrated business function that it really should be.

Revenue management automates and optimizes processes already in existence in software, content, Internet and other technology firms. Its starting point is a quote, bid, or contract. It moves through order processing and fulfillment, setup and execution of related revenue schedules, compliance with revenue recognition regulations, new and recurring business pricing, licensing and invoicing, and finally the reporting and forecasting of future revenue. In this flow, centering on information management and delivering products and services to customers, typical financial activities occur (A/R, A/P, GL entries, etc.). None of this is exotic: it makes basic sense as an extension of standard and traditional financial management. But there is a set of differentiators in this scenario that makes high-tech revenue management more visible, generate bigger impact, and exist as (arguably) more business-critical than its counterpart processes in other industries. In technology companies, three distinct elements mold revenue management:

1. Business models are constantly evolving as rapidly-developing market opportunities arise
2. The typical customer contract is multi-element, complicated, and may vary widely from other customer contracts
3. Compliance with specific AICPA and SEC guidance sets the parameters for revenue management processes that invoice, recognize, allocate, defer and report revenue

Revenue management, when done properly, increases revenue through higher efficiency and productivity while reducing operational cost. It’s at the core of the numerous product/service bundles (and their unlimited permutations) that revenue exists. And in too many corporations, multi-element contracts are handled in a way that hinders accurate and complete revenue realization, or optimized cash flow.

Accurate and detailed revenue reporting is the pivotal factor within integrated revenue management that provides the opportunity for increased cash flow. With this reporting capability, a high-tech business can rapidly and with precision identify past, present and future revenue streams. This in turn enables targeted, quantitative analysis of revenue position, installed base health, operational weaknesses and strengths, and channels for increased and repeat business. Achieving visibility allows forecasting to be a valid exercise, and increases the likelihood that plans will be achievable. Thus, understanding the comprehensive nature of revenue management enables company executives to focus on straightforward, highly effective revenue generation activities. By having a solid knowledge of all contracts at all times, efforts like proactively identifying customers who are coming up for renewal can lead to advance dialogue about renewal agreements. In some cases, pro-forma invoices can be issued ahead of time to speed up the process and promote a higher closing rate for renewal contracts. Traditional systems don’t let you do that successfully. By separating invoicing schedules from revenue schedules, though, it’s possible to individually manage receivables, cash flow and revenue forecasting.

Why is it so challenging to establish productive revenue management systems? The devil is in the details, as they say. High-tech contracts have evolved over time to encompass not just more iterations of hardware, software, services and maintenance agreements but also different methods of billing. Transaction, subscription, milestone and usage based billing are in use everywhere. Add that to the initially created license, consulting and implementation fee structures, and you automatically invite an increase in contract complexity. Increased variation and increased complexity demand more customized approaches to contract management. From the first existence of a quote or contract, the multi-element nature of the customer agreement must be understood and respected. Each aspect of the contract is essential, and the way in which it’s handled can add up, over time, to the difference between corporate viability one month, and extinction the next. It sounds like an exaggeration, but it’s a reality. In other words, the precise details of each product and service bundle, each billing model and schedule, each expiration date for product and service are what determine proper revenue management. The contract details are just the beginning, and the starting point for the bigger issue of how companies are managing their revenue throughout the entire revenue cycle.

For some companies, the most complicating factor of all is regulatory compliance. The AICPA’s SOP(Statement of Position) 97-2, 98-9 and 81-1, and the SEC’s SAB (Staff Accounting Bulletin) 101/ SAB 104 all define what elements of a contract’s revenue can be recognized at what period during a contract lifecycle. Some types of revenue can go on the books immediately. Others must be allocated over time, with a phased or “milestone” approach. The sheer volume of data that must be processed, maintained with original integrity from transaction to transaction, and used to generate revenue can be mind-boggling in and of itself.

The reality is that if you’re a technology company, you don’t ever have the luxury of automatically taking a signed contract, and handling it as if it were identical to every other customer agreement you posess. Each one generates unique revenue schedules that may need to be applied on different milestones than billing. Revenue must be separated, allocated and recognized according to which category it relates to: product, service, maintenance, etc. It is easy to misallocate, misreport and mismanage revenue within the context of compliance. It’s a confusing process, and many companies are ill equipped to deal with the operational challenges. Because revenue management is not just accounting or financials, enterprise-class systems don’t provide the specialized functionality required in technology environments. That leaves CFOs with a unique charter.

Short-term fixes are abundant. Custom-built workaround applications glue together an unsteady link between typical ERP systems (Financials, Operations, Customer Relationship Management, etc.), and small-scale systems that address the document control part of contract management. Spreadsheets become an inevitable part of this picture, and de facto errors arise from transaction to transaction. Automation is critical to process efficiency, but even more critical to process integrity and accuracy. Without the ability to rely on audit trails, guaranteeing compliance is an arduous, manual task. Without process integrity and accuracy, pinpointing in advance just those events that can be managed to produce timely revenue, is extremely difficult. To improve a technology company’s cash flow, evaluate the option of implementing integrated revenue management systems. It’s a solution that will scale as the business grows and changes.

Addendum:

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Summary Explanation of Current Regulations The AICPA’s SOP 97-2 applies directly to the software business by focusing on what has become the industry norm: multi-element contracts. It is meant to ensure that revenue for different contractual elements is recognized not on shipment alone, but also when evidence of an arrangement exists, fees are determinable, and collection is probable. Thus, license, maintenance, services and product revenues are individually accounted for with unique invoicing and revenue allocation schedules. Mandatory documental evidence of a business arrangement, like a signed contract, is used to support each contract and related schedules. In addition, charges associated with the contract need to have fixed or determinable fees. SOP 97-2 guidance also addresses revenue allocation using VSOE (vendor specific objective evidence) — price books that break out component pricing when sold separately, or prices set by management with “appropriate authority”. If there isn’t any existing VSOE for a contract, SOP 97-2 requires that the entire contract be deferred. SOP 98-9 extends the main principles of 97-2. It adds the “residual method” for situations when VSOE exists for undelivered contractual elements, but does not exist for delivered elements, but all other revenue recognition criteria have been met.

SOP 81-1 was originally developed for use in the construction industries, but has come to apply to other business segments as well, notably the software industry. In essence it sets the guidelines for using the “percentage-of-completion” method of revenue recognition. This is applicable, when a multi-element contract, typically separated out element-by-element and recognized accordingly, does not fall within SOP 97-2 parameters. When “significant modification” to original software code is required by a specific contract, then the service and license elements of that contract must be combined. In this situation, a percentage method is applied to the revenue recognition schedule for the combined elements.

The SEC’s SAB 101/ SAB 104 states that as of the fourth fiscal quarter of (fiscal) years beginning after 12.15.99, all publicly traded companies in the USA should hold to SOP 97-2-like accounting standards. The core motivation behind SAB 101/ SAB 104 is SEC concern about earnings management and early recognition of revenues.

About the Author:

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Robert O’Connor is President and Chief Executive Officer of Softrax Corporation.

With over 15 years’ experience in executive management of software companies, Mr. O’Connor has led Softrax to a leadership position in revenue management enterprise solutions. He was recognized by Ernst &Young as a finalist for their 2001 Entrepreneur of the Year Award. O’Connor 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 nation-wide. He is a guest speaker at Harvard Business School. Mr. O'Connor is a graduate of Georgetown University and received his MBA from the University of Connecticut.

Softrax is a leading enterprise software company providing revenue management solutions that fundamentally change the way technology companies manage, analyze, and predict their revenue streams. Headquartered in Canton, MA, Softrax Corporation is privately held. Further information is available at www.softrax.com or 1.888. 4 SOFTRAX.

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This article was also published in Business Credit Magazine.

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