This article was republished from a post on the Invest Before the Street blog
If you receive money from a customer that automatically counts as revenue, right?
Not so fast.
Hedge Funds: Small Firms Profit As Big Names Close In 2020
At the beginning of July, Lansdowne Partners, one of Europe's oldest and best-known hedge fund managers, announced that it was closing its flagship hedge fund after a run of poor performance. The closure is the latest in a string of high-profile hedge funds that have decided to shut up shop in recent years. Billionaire investor Read More
Meet the accounting concept behind ‘revenue recognition’.
In rare instances, companies actually get paid before any revenue shows up on the financial statements. Let’s use Network Media Group (NTE.V) as a case study.
Network Media Group, NTE.V, is a Vancouver based television and film production company. The focus of the company is developing and producing entertainment content for a global
audience. Network continues to build its production slate for three types of viewers: television (TV specials and series), film, and online.
Unlike a typical filmmaker, NTE actually pre-licenses the content and has the financing pre-arranged. They essentially get paid ahead of time by these third parties who want the films. Therefore, their costs to develop the films are already covered!
The issue with this? The revenue doesn’t show up on the Income Statement until they’ve actually delivered the film, making it a bit confusing for investors to understand the company’s growth. Let’s look at the financial statements if we search for ‘revenue recognition’:
Simply put: when the film is delivered, the company recognizes the revenue.
So let’s take a look at how it looks on the financial statements:
Since the company gets paid in advance to create the film, a ‘deferred revenue’ item pops up on the Cash Flow Statement. For 2015, this is telling us the company received $874,462 in advances to create these films that are NOT yet included as revenue.
Once these films are delivered, NTE will start to ‘recognize’ those cash flows as revenue. So how do we know how much they still have yet to recognize? Let’s look at the balance sheet:
If you look under the ‘Liabilities’ section of the Balance Sheet, you’ll see a Deferred Revenue line item. What this essentially says is that NTE has gotten paid $1,704,737 in 2015 for films they are creating, but have not finished and recognized as revenue yet.
Once those films are complete, NTE will recognize that $1,704,737 as revenue.
That’s about it! As odd as it might seem, there are a few companies that ‘recognize’ revenue like this. Be sure you always have an idea of how companies account for their revenue if you truly want to understand how fast they’ll grow.