How Unearned Revenue Impact Cash Flow?
Unearned revenue is the future obligation which the company needs to perform for the customer, it raises when company receives money before performing service. They are considered as the current liability present in the balance sheet. The company can recognize the revenue after goods or services are delivered to the customers.
Some company requires their customers to deposit a certain percentage during placing an order. It is also known as the purchase advance or customer deposit. Whatever name they use, this is the unearned revenue account that needs to class as a current liability in the balance sheet.
For example, Company ABC receives an order from a customer overseas amount of $ 1,000,000. Base on their policy, customer needs to deposit 20% so that they will start the production. The customer agrees and deposits $ 200,000, so ABC needs to record unearned revenue and present it in the balance sheet. When the goods are delivered to the customer, this balance will adjust to sale revenue.
Unearned Revenue Impact on Cash Flow
Unearned revenue is recorded on balance sheet and reflects two accounts which is cash and liability. It will not impact the income statements until it is reclassed when the sale is completed.
However, when company receives cash from customers, it will impact the cash flow statement. As we know the cash flow statements are separated into three main activities, operating, financing, and investing.
How unearned revenued impact cash flow?
Uneared revenued transaction occurs as the normal business operation, so it is classified under operating activities. Unearned revenue is the current liability, so any movement will impact the change in working capital.
Unearned Revenue Impact Cash Flow Example
Company XYZ has received a cash amount $ 2,200,000 as the customer deposit during the year. In the same years, $ 1,500,000 of unearned revenue is reclassed to income as the services have completed for the customers.
Unearned revenue at the beginning of the year was $ 500,000. Please show the impact on cash flow.
As the unearned revenue is the current liability, the impact on cash flow statement is the different between opening and closing balance. The same to current liabilities, the increase of balance will cause the cash inflow. Decrease of current liabilities will make cash outflow.
|Partial Statement of Cash Flow|
|Change in working capital:|
|Decrease in AR||XXXX|
|Increase in Inventory||XXXX|
|Increase in current liabilities (unearned revenue)||700,000 ***|
As we can see, only $ 700,000 show on the statement of cash flow while we know that company has received $ 2,200,000 during the years. Let me break down the following:
- $ 1,500,000 is reclassed from unearned revenue to revenue, so it will impact the net profit during the year. As we take profit, so this amount is already reflected in the cash flow statement.
- $ 700,000 is the increase of current liabilities which cause positive cash flow.
- So totally, the cash flow impact $ 2,200,000 ($ 1,500,000 + $ 700,000) which is the same to actual cash receive.