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Revenue recognition impact on company valuation

Posted on 16. Dec, 2008 by admin in Company Valuation

One of the key aspects when looking at comparables (revenue, EBITDA, etc) is revenue recognition.  To help illustrate revenue recognition, let’s take a company that charges clients $120,000 for services over a year long period.  The income statement shows that income at $10,000/month accounting for when the services are performed and realized by the customer (part of GAAP, the Generally Accepted Accounting Principles).  The cash flow statement, however, shows the $120,000 from the date the money is received (let’s assume it is all pre-paid).

As discussed with the comparables article, the revenue amount is critical for valuations of revenue producing startups.  The important component then of revenue recognition is that startups are valued on their income statement revenue, and not the cash flow.  This reflects when the company is building up value as measured by their customers, and not just cash.

The implication of pre-paid revenue can be advantageous, as it determines when additional capital needs to be raised.  As given in our example, the company receives the $120,000 up front which means that the company may not need to raise money as early as a company that was paid month to month for the same services.  The longer the company can forgo raising additional capital (assuming revenues are increasing) the higher the valuation put on the company when it does raise capital.

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