Revenue Management: #6 Revenue Recognition in Professional Services Industry

Revenue Management: #6 Revenue Recognition in Professional Services Industry

If you run a consulting firm, agency, or any service-based business, you have a situation where you have signed the contract, maybe even sent the invoice, and have received some initial payments. So, can you consider this as revenue? What if the project spans several months? What if there is a revision or unplanned scope creep in?


How do service-based businesses recognize revenue for time, materials, and milestones?

Revenue Recognition Scenarios in the Professional Services

This can happen to any service-based firm, like legal advisors, consultants, marketing agencies, and IT services providers, as they don't sell physical goods. Instead, they provide time, expertise, and deliverables with different timelines. This means, the revenue is recognized as work is performed and not when the invoices are sent. Here are some of the common scenarios that a service-based company faces:

Time & Material Billing

Many firms work on time and material contracts, where billing is based on hours logged. In contrast, fixed-fee projects promise a set scope for a lump sum. Revenue must be recognized based on the work delivered, not simply how much time has passed or been billed.

Example: A consultant bills $150/hour. If 40 hours are worked in April, $6000 is recognized for that month.

Bundled Services

Like SaaS, A contract might include onboarding, implementation and support. Each has a different timeline and must be recognized separately. Without clear performance obligations, firms risk misstating their revenue.


Example: A network provider sells routers, installs them, and provides support for a one-year period for $50,000. Here, the revenue earned by routers is recognized immediately; revenue from installation will be recognized as and when it is done. However, the revenue for support will be recognised only at the end of the year.

Milestone-Based Deliverables

Some contracts are milestone-based. Even if the client pays upfront or monthly, revenue must be recognized only when the milestone is met. This leads to uneven revenue patterns and complex tracking.


Example: A $20,000 marketing strategy contract has different stages, starting with $500 for discovery, $10,000 for planning, and $5000 at the time of delivery. Revenue aligns with each milestone.

Different Start Date

There can be cases where the client pays upfront for a project that begins after a few weeks. The revenue cannot be considered recognized until the project begins, and it will be deferred until the actual start date.


Example: $10,000 was paid in June for a project that starts in August. The revenue will have to be maintained as a liability/deferred until August.

Scope Changes & Goes for Rework

Projects often evolve with new tasks, changes in timeline, or even the entire deliverable gets changed. These contract modifications require updated revenue allocation and potentially re-recognition of previously booked revenue.


Example: A legal advisory firm signs a six-month contract for $60,000. After two months, the clients expanded the scope by adding training and doubling the reviews from the earlier contract, which required reallocating revenue for the remaining months.

Since service delivery isn't always linear, tracking obligation completion is essential. Manually doing this for a large-scale contract is going to be close to impossible.


Info
Scenario:

A digital consultancy service signs a contract for $60,000 with a client that includes $10,000 worth of an upfront discovery workshop. Additionally, System implementation is planned for $30,000 and will take three months to complete. Technical assistance will be offered at $20,000 for six months.  

Zoho Billing for Professional Service Revenue Recognition


Zoho Billing allows professional services firms to configure revenue recognition rules tailored to the contract's stages and services.


For the scenario above, the rule could be set as follows:

 

For Discovery Workshop

For Implementation

For Technical Assistance

Recognition Frequency

Once

Monthly

Monthly

Recognition Method

Daily

Evenly Distributed

Evenly Distributed

Recognition Time

Period Start

Period Start

Period Start

 

Once configured, Zoho Billing will take care of recognizing the revenue automatically.


It recognizes $10,000 after the discovery sessions are done. For implementation, $10,000 will be recognized per month for the next three months. For technical assistance, $3,333 per month will be recognized, which sums up to $20,000 for the committed six-month period.


Reports in Zoho Billing

If you look at the Revenue Recognition reports after two months in Zoho Billing, you can find,


i) Recognized Revenue Report

Two months into the engagement, the discovery workshop is over, two months of implementation have been delivered, and two months of technical assistance have been rendered.

Component

Recognized Revenue

Description

Discovery Workshop

$10,000

Fully recognized

System Implementation

$20,000

$10,000/month for two months

Technical Assistance

$6666

$3333/month for two months

Total Recognized

$36,666

Revenue earned in two months

 

ii) Deferred Revenue Report

The remaining revenue in deferred is for pending implementation and assistance services that are to be done.

Component

Deferred Amount

System Implementation

$10,000 (one month left)

Technical Assistance

$13,334 ($3333/month x4)

Total Deferred

$23,334

 

iii) Revenue Waterfall Report

Month

Discovery Workshop

Implementation

Assistance

Total

Month 1

$10,000

$10,000

$3,333

$23,333

Month 2

---

$10,000

$3,333

$13,333

Month 3 (upcoming)

---

$10,000

$3,333

$13,333

Month 4 (upcoming)

---

---

$3,333

$3,333

Month 5 (upcoming)

---

---

$3,333

$3,333

Month 6 (upcoming)

---

---

$3,333

$3,333

 

 

Idea

Best Practice for Professional Services Revenue Recognition

  • Define Deliverables Clearly: Break work into explicit deliverables/obligations to know how it will be delivered.
  • Match Revenue with Service Period: Use time-based or milestone-based rules depending on the service to be recognized.
  • Reassess on Scope Changes: The system should be equipped to automatically understand contract changes and recognize scheduled changes when the project terms shift.
  • Manual Revenue Recognition: It is best to use Manual Revenue Recognition based on completion for long-term milestone-based projects.
  

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