When would a company collect cash from a customer and not record it as revenue?
Answer
This is a question around Deferred Revenue: Revenue that has been paid for but cannot be recognized yet because the services have not been rendered yet. It is a liability on the Balance Sheet.
Easy answer here is SaaS, but really pick anything that has a subscription. This is one of those where you can get clever and tailor it for your industry pretty easily with real world examples. For example, let’s say you’re interviewing for a healthcare banking role. You could say:
Let’s say we were looking at a facilities management (a) company that served hospitals (b), they would likely have a multi-year contract with the hospital. Now they couldn’t recognize the entire contract value at once, they would need to recognize the monthly amortized value of the contract each month as Revenue.
Switch (a) and (b) as needed to match your industry.
This might not seem like a lot, but it’s memorable because everybody will be saying SaaS and use a vanilla example like a one-year Netflix subscription. I don’t know why everybody defaults to Netflix for anything regarding Deferred Revenue. Be creative, it will help you.
Why this matters to bankers
When creating models, bankers need to be wary of Deferred Revenue to recognize revenue in compliance with GAAP (Generally Accepted Accounting Principles). If they incorrectly recognize or forecast Revenue, it would mess up the entire financial profile of the business.