Revenue is a key process for every business. Whether you produce a product or deliver a service, you need a solid, reliable process for collecting, recording and managing revenue. Most pre-IPO companies realize the need for consistent, reliable revenue recognition, and they are not going public until they get it. Having established a process, assigned roles and responsibilities, and set up the general-ledger codes, many companies still find a significant number of revenue transactions are dealt with by exception. Such transactions generally demand a greater level of manual effort, circumvent routine controls and require individual assessment in order to establish compliance with GAAP. In addition, the complex disclosure requirements and increased level of scrutiny for a public company combined with tighter reporting deadlines make revenue recognition “the key issue” for many pre-IPO companies. While elevated pressures on company directors and executives for more accountability, better internal controls and improved risk management are not new as a result of Sarbanes-Oxley, recent economic events have created a climate in which the bar is being raised even higher. At the same time, maintaining a key focus on business operations and the bottom line remains paramount. This article reviews several areas where emerging regulations either already have or may soon impact an organization’s risk management practices and its internal control environment.

Risk
The information needs for revenue recognition are broader than the billing activities of the finance function; revenue generating activities span many departments. It may include defining a unit of activity, establishing customer-specific contract terms, capturing quantities produced or delivered, identifying and adjusting for re-work or un-billable units preparing customer invoices, managing accounts receivable and bad debts, as well as any returns or customer complaints. The potential risks include revenue leakage, complex deal structures, onerous accounting requirements and reliance on heavily manual systems and tools. There are also opportunities for significant gains: enhanced visibility to gross margins to streamline customer contract negotiations and standardize contract terms, strengthen financial reporting accuracy and improve forecasts to investors. Revenue recognition continues to be a leading issue for financial restatements and material weaknesses in internal controls.

Point of View
Be proactive. For a company planning to go public, now is the time to address your revenue recognition processes and implement a holistic, comprehensive solution. This is not an issue for the finance department alone; they do not drive sales, generate goods and services or appreciate the nuances of each and every customer. A new software system, while beneficial in many ways, will not by itself solve the problem either. The revenue recognition process starts with the business strategy, customer relations and is driven by the sales team, facilitated by operations and recorded in accordance with GAAP and corporate policies by finance. Communication and company culture are at the core of this process.
 
Ask yourself the following questions and try to identify whether you might have a problem:

1. Does your revenue policy fit your business process?
2. Is the current process reliant on manual efforts and the instincts of key people?
3. Are there any data integrity or security concerns with your financial reporting system?

Conduct a comprehensive review. What has proven successful for many organizations is conducting a comprehensive review of the revenue recognition process, tailored to the organization’s unique business goals and objectives, with input from across the organization and with sufficient time to establish change prior to an IPO. This approach focuses on strengthening the entire revenue cycle to enhance your revenue management capabilities.

Perform a gap analysis. Start by understanding your existing business processes and financial reporting requirements. Consider your information needs and those of your executive team, board and investors. With these objectives in mind, look under the covers of the current process and scrutinize the activities performed by each person including the source and content of each input, timing and transition of each sub-process and the extent of manual effort and reliance on key individuals.

Bridge the gap. Once you understand your current and desired state, you can identify the various initiatives necessary to bridge the gap between the two. It is important to prioritize and focus your attention to ensure you maximize your gains within the allocated timeframe. A typical work plan will include a number of cross-functional or cross-element projects as well as specific reviews of individual components of the revenue cycle.

Risk for Compliance Failures and Restatements
Don’t underestimate the change required. You will need input and cooperation across sales, legal, finance, operations and other departments. You will likely need to change to the company’s culture and management style. It will take time to analyze the current state, to design and orchestrate change, and time to establish operations in the desired state. One “clean” quarter will not satisfy today’s demanding and business-savvy investors.

Think about the root cause of your revenue concerns. It is unlikely to rest with a single person or department. It is less likely that system limitations are the sole cause of frustration. The reality of business today is that potential obstacles can be found at every link in the revenue chain, within each sub-process, data transfer and control point, in manual and automated processes, and at the hands of each person across the company who plays a role in the revenue process.

Communicate openly and often. Start with the obvious players and expand the team as you analyze the current revenue process, identify the source of historic problems and period-end accounting issues, and begin to understand the potential weaknesses and opportunities for improvement. Do not fear cultural change. Engage the sponsorship and support of your board of directors and executive team. The best designed process may not be enough to overcome an autonomous, competitive environment which creates walls between people, departments and information flows. That requires a comprehensive, cross-functional solution and often a change in the tone-at-the-top.