Joel Gascoigne from Buffer recently put up this post apologising for providing a wrong baseline for calculating their annualised revenue estimates. Buffer doesn’t have a CFO from what I gather and I suspect this is rather widespread amongst tech startups considering the immediate focus is to stay afloat.
Key terms like gross versus net revenue, OPEX (operating expense) and cash flow are often given a techie connotation to make it look sexy. I think it’s okay to use terms like how much ‘runway’ (cash) a business has, however founders with non-finance backgrounds must understand the fundamentals of each term used. In fact, a number of these financial metrics remain key indicators akin to symptoms a doctor looks out for before dishing out a prognosis.
Unfortunately, terms used in accounting/finance aren’t necessarily sexy and a number of finance terms make no sense until faced with a real life scenario to actualise them. Suddenly, that “Voilà!” moment happens, when you are able to apply that finance 101 principle and attribute it to real life scenario.
I have observed a key misconception amongst Nigeria’s growing ecosystem as to what revenue is and when to recognise revenue. With regards to what, grey areas are particularly evident in agency relationships (commissions, fees, etc) and in instances where contractual relationships aren’t necessarily clear cut.
Revenue recognition in reality is a job in its own right for larger organisations. This is particularly true where complex financial relationships need to be created for reasons beyond this post. If you like technical details and long-reads, there is abundance of material on revenue recognition – just Google it.
However if like me you prefer to keep it simple and understand the basics, I will attempt to summarise some of the key principles using some examples.
Example 1
I recently saw this post on Techcabal
The updated Circuitatlantic.com clocked a record $240,000 in sales this January
The quote above suggests gross revenue of $240,000 in January (annualised $2.8m). However, circuitatlantic.com charges a fee of between 5-10%, this would suggest a transaction value $2,400,000 – $4,800,000 in January alone. I doubt that is the case.
From all indications, I would assume this should read transaction value (not sales/revenue) was $240,000 translating in average revenue of between $12,000 and $24,000 (fee income).
While the transaction volume may be useful for internal management reporting/analysis, it should not be convoluted with revenue as it sends the wrong message.
Example 2
If a site acts as a middleman, earns commission or acts as a broker (e.g. a hotels booking site), then revenue (gross) in this case is the fee or commission earned and not the total value of the said transaction. This is true of sites like Hotel.ng and Jovago.com irrespective of who does the payment processing.
There are some exceptions to recognising the full transaction value. However this would depend on a primary test on the merchant versus agency relationship.
Example 3
Payment providers charge fixed and variable fees for services provided (e.g. Paga). Gross revenue in this case is the fee income charged to the merchant/customer and not the total transaction value. Example, looking at Paypal’s 2013 results, transaction volume was $180 billion and actual revenue was $6.6 billion (average 3.6% of transaction value).
Example 4
Marketplaces (e.g. Ebay, Amazon and Konga) are becoming increasingly widespread. The marketplace provider would normally charge a range of fees for services provided to the merchant. Revenue for a marketplace provider would be the various fees and charges and not the total transaction value.
There are exceptions where the marketplace provider may show revenue as gross (total transaction value) but again it would depend on the agreement, risks and rewards.
- Who is the obligor in the agreement?
- Who determines pricing?
- Who holds credit and inventory risk?
Why is this important?
Showing revenue gross or net makes no difference to bottom line results. However where revenue is shown as gross and not net (other than exceptions), this disclosure could give external users a rosier picture than it would seem.
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