In this webinar we talk about managing financial processes-billing and revenue recognition for a fixed price project.
Revenue recognition adjustments generally need to be made by professional services organizations if the contract that has been negotiated with a client defines a fixed price or time and materials with a cap agreement.
- Fixed Price – Fixed price engagements have a contractually negotiated price that the client will pay to the professional services organization in return for the completion of the project. This price will be paid to the vendor no matter how much labor the vendor needs to invest in the project. The final fixed price of the engagement may be paid all at once, periodically throughout the life of the project, or based on the completion of individual milestones. These actual payment terms don't affect how organizations need to recognize revenue in Projector.
- Time and Materials with a Cap – Time and materials with a cap engagements (for brevity, will be referred to as capped engagements) also have a contractually negotiated price cap that defines the maximum price that the client will pay to the vendor for the completion of the work. The client pays on a time and materials basis contract rates until the cap is reached. After that point, if more work remains to complete the project, the vendor is ineligible to continue getting paid. As such, a vendor can receive less revenue than defined by the cap for capped projects, but cannot receive more than the cap.
Engagements that are being delivered under pure time and materials contracts don't generally require revenue recognition adjustments. There are situations in which organizations may choose to make revenue recognition adjustments for contracts that are structured as pure time and materials arrangements, such as if a project is running over budget and management does not believe that the client can, will, or should pay the overage, regardless of the contractual language. In these situations, organizations need to exercise their own business judgment regarding how to properly recognize revenue.
Not to Exceed - for larger organizations we recommend always running revenue recognition on NTE engagements. This ensures that you do not over-aggressively recognize revenue should a project take longer to deliver than you expected. When you run revenue recognition on an NTE engagement, this has no affect on the billing of your client. You can still collect more money up front than you have officially recognized. What it does is accurately assign earned revenue based on the amount of work you have remaining to deliver the contract. For smaller organizations, they sometimes choose to run "cliffy." That is, rather than staying on top of revenue recognition, they consume all their NTE contract amount and then all subsequent timecards earn zero revenue. This can theoretically get you in trouble with auditors. Especially if it crosses fiscal boundaries. For example, you "earn" all the revenue in 2013, but then 2014 takes a hit when all your work isn't earning any additional revenue. Another case that often comes up is that you anticipate a contract extension, which ups the contract value, and prevents you from going over the cliff.
T&M - It is extremely unusual to run revenue recognition on T&M. When you do run it, what you are typically doing is telling Projector that you aren't earning as much revenue as you are billing. This is a conservative approach to recognizing revenue and is similar to using a holdback on a Fixed Price engagement. Again, remember that invoicing is decoupled from revenue recognition, so even though you are still billing the client full amounts, you aren't saying you've earned quite that much. At the end of the project you will earn the remaining balance of revenue. Or, if your delivery team failed to meet expectations and the client refuses to pay some portion of the project, you can use the system revenue holdback as a way to smooth over the unexpected short payment.