Commonly Confused Terms: Accounts Receivable (A) Versus Deferred Revenue (L)
#Finance #CommonlyConfusedTerms
Accounts receivable (A/R) and deferred revenue are both important financial concepts, but they represent different aspects of a company's financial situation.
Accounts receivable (A/R) refers to the money owed to a company by its customers for goods or services provided on credit.
Example: Apple sells a variety of products such as iPhones, iPads, Mac computers, and accessories through various channels, including its online store, retail stores, and third-party retailers. If a corporate customer purchases a bulk order of iPhones for their employees and Apple allows them to pay within 30 days, the value of that sale would be recorded as accounts receivable until the payment is received.
It is recorded as an asset on the balance sheet. Hence, an increase in A/R leads to an increase in working capital.1
Deferred revenue is the opposite. It represents money received by a company in advance of delivering goods or services.
Example: Netflix typically has a significant amount of deferred revenue on its balance sheet. If a customer pays $10 for a monthly subscription to Netflix on January 1st, but the service is provided evenly throughout the month, only $1 of that payment would be recognized as revenue on January 1st, and the remaining $9 would be recorded as deferred revenue until the end of the month, at which point all $10 would have been recognized as revenue.
It is recorded as a liability on the balance sheet. Hence, an increase in deferred revenue leads to a decrease in working capital. Furthermore, any change in working capital impacts unlevered free cash flow to the firm (FCFF)2.
Working Capital (WC) = Current Assets - Current Liabilities
FCFF = EBIT*(1-T) + D&A - CapEx - ∆WC