Definition
Deferred revenue is money a business has received from customers for goods or services it has not yet delivered. Annual subscriptions paid up front, deposits, gift vouchers and prepaid service plans are common examples. In the accounts it sits as a liability, because the business owes the customer something, and it becomes revenue as the business delivers. You may also see it called unearned revenue or a contract liability.
Worked example
Tidewater Tennis Academy is a fictional US business. In January, 500 members each pay $1,000 up front for a year of coaching, so $500,000 arrives in the bank.
- By 30 June, half the year has been delivered: $250,000 is revenue.
- The other $250,000 is deferred revenue, still owed to members as coaching.
If you buy the academy on 30 June, members will expect you to provide six months of coaching that the seller has already been paid for.
Why buyers care
When you buy a business, the obligation to serve those customers usually comes with it, but the cash they paid often does not. If the seller has already spent it, you fund the delivery yourself.
Ask for a schedule of unfulfilled orders, prepaid subscriptions, deposits and open vouchers at the expected completion date. Then agree how it is handled: as a deduction from the price, as debt in a cash-free, debt-free deal or within the working capital adjustment.
Check the accounting too. A small business using cash accounting may record prepayments as revenue on receipt, which can overstate the last 12 months.
Cash-free, debt-free is a pricing basis in which the headline price assumes the business changes hands with no cash and no borrowings. The seller keeps the cash, repays the debt and leaves a normal level of working capital behind.
Working capital is the money tied up in running a business day to day, mainly stock and money owed by customers, less money owed to suppliers. A sale needs to agree how much of it comes with the business.