For founders and finance teams, revenue is the headline number investors remember — and the one investors often scrutinize most carefully. Here’s a practical guide you can use to keep it clean, defensible, and useful for modeling and valuation.
1) The GAAP backbone (ASC 606 / IFRS 15) in plain English
Modern revenue recognition under US GAAP (ASC 606) and IFRS 15 follows a single five‑step model: (1) identify the contract, (2) identify performance obligations, (3) determine the transaction price, (4) allocate that price to performance obligations, and (5) recognize revenue as obligations are satisfied (i.e., when control transfers). Both standards are principles‑based and aligned; the details below focus on ASC 606, but the concepts mirror IFRS 15.
Two cross‑cutting ideas matter most for startups:
- Variable consideration: discounts, credits, rebates, refunds, price concessions, performance bonuses/penalties, and similar items make the transaction price variable. You must estimate these amounts up front (using expected value or most likely amount) and constrain them to what is probable before recognizing revenue — then true‑up as facts change.
- Contra‑revenue: items that reduce the transaction price (e.g., discounts or consideration payable to a customer) are recorded *as reductions of revenue*, not expenses—unless the customer provides a distinct service in return.
Other frequent startup wrinkles:
- Returns & refunds: recognize revenue net of expected returns, record a refund liability, and (for tangible goods) an asset for the right to recover returned items.
- Sales taxes: you may take a policy election to exclude sales/VAT and similar taxes collected on behalf of authorities from the transaction price (i.e., present revenue net of such taxes). Disclose the policy.
- Principal vs. agent: marketplaces/resellers must assess whether they control the promised goods/services before transfer. Agents recognize net commission; principals recognize gross revenue. Expect significant judgment here.
- Shipping & handling: if control transfers at shipping point, you may elect to treat post‑transfer shipping/handling as fulfilment cost (expense) rather than a separate revenue element.
- Significant financing component: when payment timing provides financing to or from the customer, adjust the transaction price for financing—*unless* you use the practical expedient for contracts where the gap between payment and performance is one year or less. Disclose expedients used.
2) What should be eliminated from revenue before it enters your financial model?
Before revenue hits your model, strip it back to the economics you actually earn and can repeat. That means presenting net of pass-through items (like sales/VAT) and net of customer-facing concessions (discounts, credits, rebates, expected returns). If you don’t control the underlying good or service, recognize only the agent’s commission, not gross billings; if cash comes in before performance (gift cards/credits), recognize it over time, not day one. Finally, keep your operating KPIs honest: remove one-offs when building ARR/MRR so your growth story reflects recurring value—not accounting noise.
When you turn recognized GAAP revenue into inputs for a valuation or operating model (e.g., Equidam), cleanse it for comparability and decision‑usefulness:
- Pass‑through taxes collected on behalf of governments (sales, VAT, some excise)—exclude from revenue under the ASC 606 policy election.
- Agented amounts (you arranged the service but did not control it): model net commission only, not the gross billings.
- Discounts, coupons, and price concessions (including “free months,” promotional credits, SLA service credits): treat as reductions of revenue, not marketing expense.
- Consideration payable to a customer (rebates, partner credits paid to the customer or customer’s customer): net against revenue unless a distinct service is received.
- Returns & refunds (and expected returns): model net of a realistic returns reserve (refund liability).
- Breakage estimates on unredeemed gift cards/credits should be recognized over time as customers exercise rights—don’t treat initial cash received as revenue.
- One‑off, non‑recurring items when building ARR/MRR views (e.g., setup fees if not part of the recurring service): exclude from ARR metrics (keep them in GAAP revenue).
3) What belongs as an expense elsewhere (not contra‑revenue)?
Certain cash outflows or costs should not be netted against revenue. Classifying them correctly improves gross margin transparency:
- Payment processing fees and chargeback fees → Cost of revenue/operations (they are not a reduction of the transaction price; the refund portion of a chargeback is). The refund itself reduces revenue.
- Variable consideration and refunds are contra‑revenue; third‑party fees are expenses.
- Sales commissions and other incremental costs of obtaining a contract → Capitalize under ASC 340‑40 and amortize over the period of benefit, unless the amortization period is one year or less (practical expedient to expense).
- Implementation/fulfilment costs that qualify under ASC 340‑40 → capitalize and amortize; otherwise expense.
- Bad debt / expected credit losses (CECL) on receivables and contract assets → impairment expense (typically SG&A/credit loss line), not contra‑revenue.
- Shipping & handling after transfer of control (if policy election taken) → fulfilment expense.
4) Contra‑revenue events explained: credits, discounts, returns & refunds
Startups frequently use promotions, volume tiers, credits for outages, or grant rebates to partners. Under ASC 606 these are variable consideration that reduce the transaction price and therefore revenue. You estimate them up front, apply a constraint (recognize only amounts that are probable not to reverse), and update estimates as you learn more. Returns/refunds additionally require a refund liability (and a returns asset for goods). For customers paying you, any consideration payable to the customer (like a rebate) generally reduces revenue unless the customer provides a distinct service to you.
- Allocate discounts to performance obligations based on standalone selling prices unless a specific exception applies.
- Estimate refunds/returns and recognize revenue net with a refund liability.
- SLA credits, promotional credits, and free months reduce revenue, not COGS or marketing.
- If you pay the customer (rebates, co‑op funds), reduce revenue unless you receive a distinct service.
5) ARR done right (and how it differs from annualized run rate)
ARR (Annual Recurring Revenue) is the annualized value of contracted, recurring subscription revenue that is in effect at a point in time. Exclude professional services, setup fees, and other one‑time items—even if they recur irregularly. For usage‑based models, include only the contracted recurring component (e.g., minimums/committed spend); report variable usage separately or as trailing actuals with clear policy. The SaaS Metrics Standards Board and leading practitioner guides emphasize this contract‑based, recurring definition.
Annualized run rate (sometimes called “revenue run rate”) typically multiplies the latest month’s revenue by 12. It is not necessarily recurring, can be distorted by seasonality, one‑offs, or implementation milestones, and should be clearly labeled as such under SEC KPI guidance (define the metric, explain why it’s useful, and disclose changes to the calculation).
ARR / MRR checklist
- ARR = sum of annualized recurring contract value for active subscriptions at period end (include upgrades/downgrades and churn immediately).
- Exclude: one‑time fees, services revenue, hardware pass‑throughs, and non‑contracted overages.
- Be explicit on usage‑based treatment (minimums vs. overages).
- Disclose definitions and any changes (SEC KPI guidance).
6) Common pitfalls to avoid in reporting
Even well-run startups trip over revenue reporting—not because of bad intent, but because small shortcuts compound into big credibility problems. The most common mistakes stem from muddling key concepts (bookings, billings, revenue), choosing the wrong gross vs. net presentation, or underestimating the impact of discounts, returns, and credits. Add in overlooked policy elections, mis-handled commissions, and sloppy KPI definitions, and you’ve got numbers that won’t survive investor or auditor scrutiny. Use the checklist below as a guardrail: keep definitions tight, document judgments, and make sure your ARR narrative matches the economics—not just the invoice cadence.
- Bookings, billings, and revenue ≠ the same thing. Bookings are contract signatures; billings are invoices sent; revenue follows transfer of control. Don’t use bookings or cash as proxies for GAAP revenue.
- Big‑Four guides emphasize keeping these concepts separate.
- Misclassifying principal vs. agent. Reporting gross instead of net (or vice versa) can materially misstate revenue. Document your control assessment and revisit when terms change.
- Insufficient variable consideration estimates. Under‑reserving for discounts/returns causes later reversals and credibility hits. Apply the constraint consistently.
- Treating consideration payable to customers as marketing. Unless you receive a distinct service, it’s contra‑revenue.
- Forgetting policy elections and disclosures (taxes, shipping, financing expedients). Investors notice when disclosures don’t match the numbers.
- Amortizing commissions incorrectly (e.g., on bookings rather than the period of benefit). Follow ASC 340‑40 and the one‑year expedient.
- Running ARR off GAAP revenue without cleaning for one‑offs. That’s annualized run rate, not ARR—and the SEC expects clear definitions for KPIs.
7) Practices to actively avoid (these are red flags)
Some practices don’t just muddy your numbers, they invite enforcement, restatements, and reputational damage. Anything that manufactures revenue without real economics, pulls sales forward to hit a target, or dresses KPIs in wishful thinking is a bright red flag for investors and regulators. Hold a zero-tolerance line here: recognize revenue only when earned, present results without gimmicks, and define KPIs so they can’t be gamed. Use the list below as your anti-pattern checklist — if it feels like “making the quarter,” it’s probably breaking the rules.
- Round‑tripping / sham trades: reciprocal sales with little substance to inflate revenue. The SEC has flagged these arrangements repeatedly.
- Channel stuffing: shipping excess product to distributors at period‑end to “make the quarter.” Enforcement attention remains high.
- Bill‑and‑hold without meeting criteria: recognizing revenue before delivery without compliant documentation and customer requests. The SEC issued specific guidance tied to ASC 606 adoption.
- Inflating MRR/ARR: counting non‑recurring items, pipeline, free trials, or unsigned renewals; failing to reflect downgrades/churn immediately. SEC KPI guidance requires precise definitions and consistency.
- Non‑GAAP measures that back out normal cash operating costs to create misleading “adjusted revenue” or “cash margin” narratives. Expect SEC comments.
8) Quick reference: where to put what
Reduce revenue (contra‑revenue):
- Discounts, coupons, promotional credits, SLA service credits, price concessions.
- Consideration payable to a customer (rebates, co‑op funds), unless you receive a distinct service.
- Returns/refunds (use a refund liability); chargeback refunds.
- Pass‑through sales/VAT taxes (policy election).
- Agented amounts where you don’t control the goods/services (recognize net).
Expense elsewhere:
- Payment processing and chargeback fees → Cost of revenue/operations.
- Sales commissions / incremental contract costs → capitalize & amortize (or expense using one‑year expedient).
- Shipping & handling after transfer (if elected) → fulfilment expense.
- Bad debt / CECL on receivables and contract assets → credit loss expense.
FAQ — People also asked
Q1) How should we treat “free months” or promotional credits in SaaS?
As variable consideration that reduces the transaction price. Allocate discounts across performance obligations based on standalone selling prices; recognize revenue net over the service term.
Q2) Do implementation/setup fees count toward ARR?
Generally no. ARR should reflect only *recurring* subscription revenue; one‑time fees are excluded (even if frequently occurring across customers).
Q3) We’re usage‑based—can we include overages in ARR?
Best practice is to include only contracted minimums/committed spend in ARR and disclose how you treat variable usage (e.g., shown separately or on trailing actuals). Be explicit and consistent.
Q4) Where do we put sales commissions?
ASC 340‑40 requires capitalizing incremental costs of obtaining a contract (e.g., commissions) and amortizing over the period of benefit, unless that period is one year or less (expedite to expense).
Q5) Are bad debts a reduction of revenue?
No. Expected credit losses on receivables/contract assets are impairment expenses under CECL, not contra‑revenue. Don’t net them against revenue.
Q6) Can we show “gross marketplace revenue” even if we’re an agent?
Not in GAAP revenue. If you’re an agent, recognize net; you may present GMV as a KPI with clear definition and reconciliations, but your GAAP revenue should be net.
Q7) We invoice annually upfront—do we need to separate a financing component?
Only if the timing creates a significant financing component; many SaaS contracts qualify for the practical expedient when the gap between payment and performance is one year or less (disclose the expedient).
Final takeaway for Valuation
Before you plug “revenue” into your valuation model, pass it through a clean room: remove pass‑through taxes, net out credits/returns, present agented amounts on a net basis, and classify costs (commissions, processor fees, shipping, bad debts) outside revenue. Then build ARR from contracted recurring pieces only—and label anything annualized from a single month as “run rate,” not ARR, with clear KPI disclosures. That combination gives you numbers that are both GAAP‑defensible and investor‑useful.