Definition:

Deferred Income, also known as unearned revenue, refers to the advance payments a company receives for goods or services that are to be delivered or performed in the future. It is recorded as a liability on the balance sheet until the service is provided or the product is delivered, at which point it is recognized as revenue.

Examples

Examples of Deferred Income include subscription services (such as magazines or software), annual maintenance contracts, and prepaid insurance premiums. For instance, if a magazine company receives payment for a one-year subscription, the revenue is recognized monthly as the magazines are delivered.

Formula:

Deferred Income = Total Payment Received - Revenue Recognized

How to use the metric:

Deferred Income is used to understand the amount of revenue a company has yet to earn from advance payments. It helps in assessing the company's future revenue streams and cash flow. Analysts and investors use this metric to evaluate a company's financial health and predict future earnings.

Limitations:

Deferred Income does not provide insights into the timing of revenue recognition, which can vary based on the company's accounting policies. It may also not accurately reflect the company's current financial performance, as it includes future obligations. Additionally, it can be manipulated by altering the timing of revenue recognition.

Applies to:

Deferred Income is applicable in industries where advance payments are common, such as subscription-based businesses, insurance, telecommunications, and software-as-a-service (SaaS) companies.

Doesn't apply to:

Industries that primarily operate on a cash-on-delivery basis or where services are rendered immediately upon payment, such as retail or hospitality, may not frequently use deferred income, as there is little to no delay between payment and revenue recognition.

Summary:

Deferred Income is a financial metric representing advance payments for future goods or services, recorded as a liability until recognized as revenue. It is crucial for understanding a company's future revenue potential but has limitations in reflecting current financial performance. It is most relevant in industries with subscription models or advance payment structures.