Mastering revenue recognition

Improper revenue recognition continues to top enforcement actions by the Securities and Exchange Commission last year, consistent with previous years although the number of actions is down by a third as the Biden administration transitioned into its role amid the pandemic, according to an analysis by Cornerstone Research.

The SEC took only 34 actions, compared to 50 in the last year of the previous administration, and all of them were administrative proceedings, which means they were presented to an administrative law judge rather than a U.S. district court. It was the first time in four years no civil actions were initiated. Administrative proceedings tend to move more quickly than civil actions.

About a third of the actions concerned inaccurate revenue recognition, including two that involved ASC 606 standards that took effect a few years ago for public companies and more recently for private companies and nonprofits.

The standards govern how organizations allocate revenue tied to contractual performance obligations, which can get complex when the term extends over multiple reporting periods. 

One of the revenue recognition actions stemmed from the earnings per share (EPS) initiative the SEC launched in 2020. The initiative uses data mining to identify reporting anomalies that could be the result of misreporting.

In the one EPS case, the SEC in August hit Healthcare Services Group with a $6 million settlement charge for leaving loss contingencies out of its reporting, allegedly as a way to inflate its quarterly earnings per share (EPS) to align with analyst estimates. The CFO and controller were also hit with settlement charges.

When it announced the action, SEC Enforcement Chief Gurbir Grewal touted the initiative. “As today's actions demonstrate, we will continue to leverage our in-house data analytic capabilities to identify improper accounting and disclosure practices that mask volatility in financial performance,” he said.  

Inadequate controls

The big enforcement area in addition to revenue recognition last year applied to companies’ internal accounting controls.

In one case, Tandy Leather Factory allegedly failed to maintain inventory cost information and used an inventory tracking system that didn’t support the company’s inventory accounting methodology.

"Tandy’s inventory tracking system and related controls were critical to both its business and the information it provided investors, yet they were wholly insufficient,” said David Peavler, director of the SEC’s Fort Worth regional office. 

In addition to its other sanctions, the SEC imposed monetary settlements totaling $158 million, a big drop from $1.4 billion the previous year and $670 million in 2019. 

The SEC’s enforcement chief said penalties could go up if “historical penalty amounts are not having the desired effect,” Grewal said. 

Civil penalties accounted for about two-thirds of the settlement amounts, while disgorgement and prejudgment interest accounted for 31% and 6%, respectively. 

No-admit settlements

Notwithstanding an SEC policy shift in October to move away from so-called no-admit settlements, none of the actions last year included admissions of wrongdoing. That means those charged with violations were able to settle without admitting or denying guilt. In its policy shift, the SEC said it wants to make these no-admit settlements harder to get.

“When it comes to accountability, few things rival the magnitude of wrongdoers admitting that they broke the law,” said Grewal. “We will, in appropriate circumstances, be requiring admissions in cases where heightened accountability and acceptance of responsibility are in the public interest.”

Treat incremental commissions like a fixed asset to properly account for them under ASC 606 revenue recognition standards, according to Ryan Dillard of technical accounting firm CBIZ ARC Consulting. 

ASC 606 standards went into effect in 2018 for public companies and this year for private companies and nonprofits, so many startups are still grappling with implementation, and accounting for commissions is one of the pain points, Dillard said.

The challenge stems from the need to capitalize, and then amortize over time, commissions that are considered incremental expenses because they're tied to contracts with performance obligations that are met over more than one reporting period. 

“That was kind of a wake-up call to a lot of our clients,” said Dillard, whose company works mainly with software-as-a-service (SaaS) technology companies. “They hadn’t thought so much about this cost aspect having to be a heavy lift.” 

Incremental costs

To understand which commissions are incremental and need to be capitalized and amortized in the P&L, determine which commissions are tied directly to obtaining a sales contract, Dillard said.

Sales-related costs that aren’t directly tied to the contract, such as compensation to people to make lead-generation calls that happen whether or not the contract closes, would not be considered incremental. Nor would travel costs to make a sales pitch to a potential customer, since those costs would be incurred even if the contract didn’t close. Only the commission and any other costs — including, for example, payroll costs, or incentive pay, tied to the commission — that are incurred only if the contract closes would meet the incremental definition. 

Once you have those costs identified, you have to decide the period over which they need to be amortized. This can get tricky, he said, because it depends on the length of the contract, whether or not the client is expected to renew after the contract term, and whether the technology the client is paying for changes so much during the contract period that it’s no longer functionally the same software. 

“I think of it as having two goal posts,” Dillard said. “The shortest period you would probably amortize it is your initial contract period. The longest would probably be your customer life. But in reality it’s going to be something shorter than that, because there are things you need to take into consideration — some of your churn rates, changes to the technology. Is it really the same product today as it would be in four, five or six years?”

Most companies he works with assume an amortization period of four to five years, which might include an initial three-year contract period and two one-year renewals. In a case like that, if the salesperson is paid a $30,000 commission, you might expense 80% of the commission upfront and then amortize the balance over the term of the period you assume. 

“You might accumulate these commissions over a month or a quarter, and then you’re going to set up that number as a kind of commission asset, and then you’re just going to bleed it out,” he said. “It’s going to look very much like a fixed asset schedule.”

Most of the companies he works with do their initial scoping in Excel, set it up in NetSuite and then give it an amortization period.

Chart of accounts

To get it right, controllers might expect to keep their normal commission process as-is in the P&L and then set up new GL accounts to track the amortizations.

“So, you’re going to have a contra-commission expense account,” he said. “You’re going to have your normal commission expense in the P&L, where it’s going to flow through. Then, you’re going to have a contra account, and that way you can track what’s being capitalized each period, what’s being pulled out and put on the balance sheet. And then on the balance sheet side, you’re going to have, just like a fixed asset, your gross commission asset that you’re amortizing, an accumulated amortization account. You have these two accounts on the balance sheet, and the contra-expense account. Then you have another amortization expense account for commissions on the P&L.”

Using this process, assuming a company had $1 million in commission expense, you might capitalize $300,000. “We can track it in the gross fixed asset, and then that amortization expense is getting picked up in your accumulated amortization account, and you have this new amortization expense account in the P&L. It’s a nice way to map everything and track it.”

A former revenue recognition manager at optical networking company Infinera Corporation used his position to tip unannounced quarterly earnings and financial performance to a contact, who shared the information with a wider trading ring to generate illegal profits, the Securities and Exchange Commission has charged. 

The group made about $1.7 million in profits and avoided losses in a roughly 18-month period before the rev rec manage, Nathaniel Brown, left his job.   

The charge is the latest to come from a data analytics tool the SEC began using last year. “Using sophisticated data analysis, the SEC was able to uncover this insider trading ring and hold each of its participants accountable to ensure the integrity of our markets,” Joseph Sansone, an SEC enforcement chief, said.

According to the complaint, Brown repeatedly tipped Infinera’s unannounced quarterly earnings and financial performance to Benjamin Wylam, a high school teacher and bookmaker, who traded on the information and also tipped it to another contact, Naveen Sood. 

Sood allegedly traded on this information and also tipped it to three contacts, Marcus Bannon, Matthew Rauch and Naresh Ramaiya.

The ring also illegally traded on insider information from another company, the SEC said. 

In this other arrangement, Bannon tipped Sood with material, nonpublic information about Bannon’s employer, Fortinet Inc. Bannon learned in early October 2016 that Fortinet was unexpectedly going to announce preliminary negative financial results. Bannon tipped this information to Sood, who used it to trade and also tipped it to Wylam and Ramaiya. 

The SEC’s complaint charges Brown, Wylam, Sood, Bannon, Rauch, and Ramaiya with violating the Securities Exchange Act of 1934. Bannon agreed to pay a civil penalty of $281,497, Rauch a civil penalty of $128,230, Ramaiya a civil penalty of $65,780 and Sood a civil penalty of $178,320. The final judgments require court approval.

Wylam has consented to a permanent injunction with any civil penalties to be decided later in court. SEC litigation against Brown is continuing.

Separately, the U.S. Attorney’s Office for the Northern District of California is looking at related criminal charges against Brown, Wylam, and Sood.

When Jody Cire was interim CFO at LogRhythm in 2018, the cyber security company was bedeviled by a volatile revenue stream. It booked its business and recognized revenue upfront as an on-premises software company. In any given quarter, in addition to its bread-and-butter smaller deals, it might book half a dozen million-dollar enterprise deals — or it might book only half of that. And that degree of volatility was a key reason the company was unable to go public when it had tried to in the past.

"Investors and investment bankers want predictability," said Cire, now CFO of AllCloud, a professional services company that helps clients optimize their cloud spend.

To smooth out its revenue, LogRhythm could either pivot to a subscription-based, on-premesis licensing model, or it could reinvent itself as a software-as-a-service (SaaS) company. But both of those options entailed disruptive changes that finance couldn't fully control.

Cire spied an opportunity to make a change, however, when the Financial Accounting Standards Board (FASB) that year released guidelines on its new ASC 606 revenue recognition standard. The standard took effect at the beginning of this year.

Under the guidelines, if your company has an ongoing delivery requirement for its customers, you can adopt a ratable revenue recognition model that lets you spread your revenue over a period of time. 

Although LogRhythm's product wasn't antivirus software that required daily definition updates, it did require updates that would qualify it for the ratable accounting method. And that proved to be a crucial change, Cire said last week in a CFO Thought Leader podcast; it enabled the company to smooth out its revenue as recognized in its P&L.

"Even though our booking and billings would still be lumpy, at least our P&L would be smooth," said Cire, who joined AllCloud 15 months ago after a six-year stint at LogRhythm. "The bankers loved it."

Cire said the new system positioned the company to go for the IPO that previously eluded it but it chose not to go that route; instead, it opted to be acquired by Thoma Bravo, a private equity firm specializing in enterprise software companies. 

"Thoma Bravo loved that most of the work [migrating to a subscription model] had already been done," he said. "Now all we had to finish migrating was the billing model and work the architecture into a SaaS model. So, finance basically led the charge in smoothing our lumpiness."

Tech focus

Since his early days as an external auditor for KPMG, Cire has specialized in tech companies, particularly startups. At AllCloud, he focuses on building an infrastructure that can accommodate the company's plan to grow through acquisitions. 

"We were born with the idea of being a hub for merging multiple companies together," Cire said. "We started with raising money to buy an existing company, and then within less than a year bought another company, so we started off as a hub and spoke model."

And yet the company hadn't fully thought through what its back-office systems and processes needed to be to accommodate that model. 

"As you bolt on new companies, they need to be on the same systems and also the same instances of those systems," he said, whether it's for sales, professional services, accounting, payroll, or banking. "We've never done any of that. I've got five countries right now and we're in the middle of rolling out NetSuite, but as I sit here today I’ve got five different general ledgers in five different countries. Simply to close the books is a much bigger manual effort than it should be."

The five countries the company operates in are the U.S., Canada, Israel, Germany and Romania. 

Team hires

To help him build his system and processes, Cire brought on board key members of his team as one of his first orders of business at AllCloud.

"We were pretty raw in all things back-office," he said. "We were not only understaffed but under-skilled. I did have to replace my former head of finance and accounting and bring in someone senior to that individual."

In addition to finance and accounting, Cire oversees Legal and IT, whose top person he had to replace. 

"We ended up taking one of the founders of a company we acquired who's a Salesforce expert and used to be an ERP consultant," he said. 

The person had experience implementing accounting systems and was also well versed in professional services. "We promoted him into senior vice president of information systems and information technology, and he's been an amazing hire," he said. "He's also taken on all of the compliance functions, so everything about ISO and GDPR."

ISO refers to the ISO 9001 management quality standard, and GDPR refers to General Data Protection Regulation, the European Union’s comprehensive data privacy and security law.

Growth despite pandemic

For 2020, Cire said, AllCloud had completed its budget process early — by January 6 — but the fast work was quickly superseded by the pandemic, forcing his team to come up with an alternative plan it calls its COVID re-forecast.

"Originally we were forecasting over 40% growth," he said. "But even in the COVID re-forecast, we still see growth: it’s about 25% to 27%, year-over-year."

The reason for the relatively optimistic picture is the nature of its business. As a company that helps its customers optimize their use of the cloud, it’s well-positioned as its customers rely on cloud systems to keep their operations going remotely during the pandemic.

"This sudden transition, with everyone having to work from home, really supports our line of work," he said.

"No one would ever wish [the pandemic] on the world," he added. "And we've had to cut and project slower growth. But this raises to everyone's awareness that the cloud has tangible benefits."

The Securities and Exchange Commission (SEC) fined the two former top executives of WageWorks, a flexible-spending accounts provider, for directing accounting staff to recognize revenue the executives had little reason to believe would be received.

In an agreed-upon settlement with the SEC, former CEO Joseph Jackson was penalized $75,000 and directed to repay WageWorks $1.9 million in incentive pay he earned, and former CFO Colm Callan was penalized $100,000 and made to repay $158,000.

"The SEC exercised its longstanding authority to hold executives accountable through clawbacks by requiring Jackson and Callan to reimburse WageWorks for compensation they received stemming from their violations," said Melissa Hodgman, acting director of the SEC's enforcement division. The company wasn't charged with any wrongdoing. 

The violations stem from the executives' insistence on recognizing revenue for work their company undertook to take over the administration of flexible-spending accounts of a large public-sector employer.

Even though the client repeatedly said it would not pay for the company's development and transition work — instead, it would just pay an agreed-to monthly per-account fee — the executives directed accounting staff to amortize recognition of development and transition revenue on a quarterly basis.

In total, the company recognized $3.6 million in revenue for its development and transition work over several years. 

Recognition of the revenue helped boost the company's stock price to more than $75 a share, a high, enabling Jackson and Callan to tap stock-based incentive compensation. 

"On the basis of this performance, WageWorks awarded Jackson a bonus of 50,000 shares of WageWorks common stock [and] Jackson and Callan both earned cash bonuses," the SEC said.

Over the course of several years, while the executives were directing accounting staff to recognize and amortize the development and transition revenue, the client was insisting it wouldn't pay for the work.

"At no point prior to recognizing [that] revenue ... did Callan tell WageWorks's internal accounting staff or the audit firm staff that Client A employees had twice indicated that Client A was not going to pay WageWorks for [that work]," the SEC said.

Regardless of whether Jackson and Callan believed their company was entitled to payment for the work, recognition of that revenue is improper under GAAP, the SEC said, because the company didn't have reason to believe it would be coming in. 

"Because Client A had indicated to WageWorks that it would not pay for [that work], WageWorks's collection of [those] revenues was not realizable or reasonably assured," the SEC said. 

"Jackson and Callan repeatedly failed to share important information about WageWorks's ability to collect a significant receivable with WageWorks's internal accounting personnel and external auditor," said Erin Schneider, director of the SEC's San Francisco regional office. "Public companies and their executives must consider all material facts — not just the ones that are favorable to their position — when making financial reporting decisions."

The time to ensure you have the right processes in place to comply with the ASC 606 revenue recognition rules is now, especially if you sell direct to consumers and expect to generate a lot of income during the holiday season, accounting pros said in a CFO.com webinar.

The Financial Accounting Standards Board (FASB) adopted Accounting Standards Codification (ASC) 606 in 2014 to tie revenue to when control of a good or service transfers to a buyer under a contract rather than when the supplier satisfies its obligation. The change, on its surface, seems modest. But it requires companies to exercise more judgment on when revenue, and expenses to generate them, is recognized.

The rules took effect for public companies last year. The requirements kick in for private companies at the end of this year.

700 pages of guidelines

Because of the complexity embedded in the 700 pages of guidelines, it's a good idea for your accounting team to work through your processes with your outside auditors as a kind of trial run if you haven't already done that, said Sarah Blake Semendinger, controller for The Great Courses, an education company.

"You do not want something like this to be the holdup to a clean opinion," she said. "By working with them in the interim, you can ensure a smoother audit."

The guidelines outline a five-step process for recognizing revenue:

• Identifying your contract with a customer
• Identifying your performance obligations under a contract
• Determining the transaction price
• Allocating the transaction price
• Recognizing revenue

More than under current procedures, you'll need to work with the heads of your IT, legal, sales and other departments, because the decisions they make can affect how you recognize expenses and revenue, said Christophe Cantenot, director of revenue and financial reporting for Dexcom, which provides a way for people to use their phones to monitor their glucose levels.

How contract terms are written can make a significant difference in how you recognize money coming in or going out. And if you don't coordinate well, you can face a big drop in revenue in one reporting period versus another, he said.

"In sales, you want to work with those in charge of the relationship with your clients and those in charge of the contracting side," he said. "You need to have someone with revenue knowledge review the agreements with your customers before executing."

The rules affect how the sales team expenses its acquisition costs and applies its commissions.

"We had to go through a deep dive assessment on whether those sales commissions should be considered like contract acquisition costs," he said. "In the past, we were expensing those sales commissions. ... If the expected amortization period of those costs is less than a year, then you can continue to expense them as you incur the expense. So it did change the way we were looking at the business, forced us to spend more time with HR, the sales team, and look at the way they were compensated."

Distribution channels

For a company that sells to consumers, how those goods or services are distributed makes a difference in how revenue is recognized.

Semendinger's company, which sells education courses, distributes their products in two ways: directly to consumers, and through a distribution arrangement with Amazon's Audible. It also produces courses exclusively for Audible and sells a subscription product through an app.

"You can't always assume the relationship is the same as last year," she said. "Look at your net versus gross or principal agent relationship. Look at those contracts each year when they get renewed."

Semendinger has to look at whether the digital subscription product is distributed through iTunes or Google Play Store. "So, we're looking at how those contracts are renewed, when terms and conditions change, from Apple or Android. We have to analyze to ensure the whole net versus gross or principal agent hasn't changed."

Because decisions made by the legal team on how contract terms are written and how sales are recognized, it's imperative your finance team works with leaders in legal and sales so they understand how their decisions affect your assumptions. IT needs to be involved, too, because it needs to set up systems so team leaders can collaborate.

"Marketing is probably the biggest impact for me," Semendinger said. "We design our campaigns so far out in advance. I need to remind them to keep us in the loop, especially on these holiday catalogs. We still look at things on a quarterly basis and how campaigns change from one year to another as far as timing.

"So, when we're comparing revenues and expenses, from, say, the second quarter last year to the second quarter this year, if they make a change by just a few days, on when a campaign would go live, that could have a huge swing from quarter to quarter. Especially coming into the holiday season, as you can imagine being a retail company, a lot of our sales are done from Black Friday through the Christmas holiday, and the timing of when we start those campaigns” determines how much revenue we can recognize and when," he said.

The pandemic is increasing financial reporting fraud, putting the onus on CFOs to create an organization-wide system that prevents wrongdoing, a coalition of auditing and other oversight groups said in a report released today.

"Financial statement fraud in public companies is real and that risk has only increased during the Covid-19 pandemic," said Julie Bell Lindsay, executive director of the Center for Audit Quality, one of four groups to release the report.

To help ensure the integrity of their company's financial reporting, CFOs can't rely on external auditors as their bulwark against fraud; they must weave protection into the fabric of the organization and exercise the same skepticism toward numbers auditors are trained to do.

"The strongest fraud deterrent and detection program requires extreme diligence from all participants in the financial reporting system," Lindsay said. "Certainly, you have internal and external auditors, but you also have regulators, audit committees and, especially, public company management."

Heightened stress

The report looks at SEC enforcement data from 2014 to 2019, a period of relative calm Linsday said can help set a baseline for assessing how much in pandemic-caused fraud regulators will find when they do their post-crisis analysis.

"The timing of this report is really a great way to ... remind all the folks in the financial reporting ecosystem that ... the pressures for fraud to happen are strong right now," she said. 

Improper revenue recognition comprises about 40% of wrongdoing in financial reporting, more than any other type, a finding that tracks an SEC analysis released last August. 

Companies tend to manipulate revenue in four ways:

1. The timing of recognition
2. The value applied
3. The source
4. The percentage of contract completion claimed

The report singles out revenue-recognition manipulation by OCZ Technology Group, a solid-state drive manufacturer that went bankrupt in 2013, as a typical case.

The company had to restate its revenues by more than $100 million after it was caught mis-characterizing sales discounts as marketing expenses, shipping more goods to a large customer than it could be expected to sell, and withholding information on product returns.

The CEO was charged with fraud and the CFO with accounting, disclosure, and internal accounting controls failures.

The report lists three other common types of fraud: manipulation of financial reserves, manipulation of inventories, and improper calculation of impairment.

Reserve issues involve how, and when, balances are changed, and how expenses are classified; inventory issues involve the amounts that are listed and how much sales cost; and impairment issues involve the timing and accuracy of the calculation. 

Increase expected

More of these kinds of problems will likely be found to be happening because of the pandemic, the report said. 

"This is where all of this comes to a head," Lindsay said. "You certainly can see pressure, because some companies are struggling right now and there can be pressure to meet numbers, analysts expectations."

The pressure finance professionals face is part of what the report calls a "fraud triangle," a convergence of three factors that can lead to fraud: pressure, opportunity and rationalization.

In the context of the pandemic, pressure comes as companies struggle with big drops in revenue; opportunity arises as employees work remotely; and the rationalization for fraud is reinforced by the unprecedented challenges people are facing. 

"It could be anything," said Lindsay. "‘My wife just lost her job, so I need to make up for it.'"

The report lists fraud types that analysts expect are rising because of the pandemic:

• Fabrication of revenue to offset losses.
• Understatement of accounts receivable reserves as customers delay payments. 
• Manipulation of compliance with debt covenants. 
• Unrecognized inventory impairments.
• Over- or understated accounting estimates to meet projection.

About a dozen types in all are listed. 

"Past crises have proven that at any time of large-scale disruption or stress on an economy or industry, companies should be prepared for the possibility of increased fraud." the report said. 

Lindsay stressed three lessons she'd like to see CFOs take away from the report.

First, the potential for fraud in their companies shouldn't be an afterthought. Second, protection against it is management's responsibility but there's also a role for company's audit committee, its internal auditors and it's external auditors. Third, CFOs and the finance executives they work with, including at the middle management level, must bring that same skepticism toward the numbers that auditors are trained to bring.

"Professional skepticism is a core competency of the external auditor and, quite frankly, the internal auditor," she said. "Management and committee members are not necessarily trained on what it is, but it doesn't mean you shouldn't be exercising skepticism, [which is] asking questions about the numbers that are being reported. Is this exactly what happened? Do we have weaknesses? Do we have areas of positivity? It's really about drilling down and having a dialogue and not just taking the numbers at face value."

In addition to the Center for Audit Quality, Mitigating the Risks of Common Fraud Schemes: Insights From SEC Enforcement Actions was prepared by Financial Executives International, The Institute of Internal Auditors and the National Association of Corporate Directors.

Consumers today value convenience and speed above almost anything else. The subscription business model delivers on both, which is why it is increasingly appealing for companies.

Subscriptions aren't new, and have in fact been around longer than we might realize. Decades ago, we started paying monthly for gym memberships, newspaper deliveries, and our utilities. Then we replaced our DVD sets with Netflix logins and our in-car CD players with Sirius XM Radio. In the past couple of years, subscription boxes started to boom, delivering ready-made meals, outfits and beauty and grooming supplies to our door. Now, in the midst of a pandemic, we find ourselves surrounded by subscription-based services for every activity. Not only do we have on-demand fitness classes and regular wine deliveries; we also have the option of memberships for private air travel and home maintenance services.

A recent PwC CFO survey found that 63% of CFOs are planning changes to products or services and 41% are looking to alter pricing models. And it makes sense. Subscription pricing, which is one type of model, can help stabilize and extend a company's revenue stream while building a customer relationship and delivering on the convenience that consumers crave.

Aside from the obvious financial benefits of the subscription model, CFOs also see its value in terms of placing finance teams front-and-center in the evolution of the customer experience. Subscription models represent the end of product ownership — something that has defined the buyer and seller relationship for centuries. Rather than a seller transferring ownership rights to a buyer upon sale, subscription agreements give buyers the right to access seller-owned products, services and experiences whenever they want.

As with most good things, there are some challenges to the subscription model. Adding or migrating to a subscription model introduces the risk of complicating company financials reporting. As a result, CFOs need to balance financial discipline with strategic flexibility when making this move.

Here are three tips for CFOs to do just that:

1. Resist moving revenue recognition outside of your ERP

The main challenge with migrating to a subscription model is the degree of cultural and organizational change that is necessary. Subscription renewal cycles require as much time and attention as new sales opportunities. Sales and marketing teams have to shift their focus away from closing big deals to developing long-lasting customer relationships. Customer satisfaction is paramount, meaning product development teams are constantly rolling out new features and improvements. Now, the marketing, sales, service and finance functions are all intimately involved in customer relationships — and therefore, the revenue stream. 

To overcome these challenges, CFOs should invest in a subscription management system and integrate it with their finance system to support a move to a recurring revenue model. But instead, CFOs often decide to use their existing CRM and ERP systems because it's easier. At their core, ERP systems were designed to support traditional pricing models – not to manage the complex, dynamic and customer-facing structure of subscription models. Additionally, the lack of integration between a CRM and an ERP in the reporting process can lead to inaccurate forecasting, revenue leakage, and improper revenue recording.

A common workaround for this challenge is to implement outside subscription billing management systems, creating even more data silos. It leads to invoices being passed as a single, collapsed line item with no detail. If finance teams cannot see the invoice details at a granular, line item level, the team cannot report against the individual components of the order or understand the customer's full history. Ultimately, going outside the ERP system decreases visibility into the success of a subscription model, impacts reporting and tracking, and opens up a can of worms on compliance issues.

The best option for a company looking to implement a subscription business is to integrate a subscription management system with your existing ERP system, in order to measure the success of the pricing model and scale your business for the long term.

2. Take the long view on reporting and analytics

With subscription models, you have to play the long game. Gone are the days of "one-and-done" transactions; we're now in the age of life-long relationships with your customers. Your financial reporting needs to mirror this evolution of your business strategy.

To truly measure the success of your business, financial reports need to encompass more than just what has closed this month or quarter. Instead, they have to focus on the long view in terms of revenue health and overall company profitability. This means avoiding the temptation to add manual processes or keep information on multiple systems, which can make it difficult to manage mid-term changes and cancellations. One of the benefits of a subscription model is that revenue and cash flow become more predictable, allowing you to forecast beyond the next quarter — however, this is only true if your financial reporting keeps this in mind too. 

Measuring your progress and being able to make adjustments is critical, and defining clear KPIs and sticking to them will help keep you on track toward your business goals. But more importantly, CFOs need to determine a process to track these metrics on a continuous basis. Without a real-time, detailed, and clear view of them, finance teams will struggle to manage the transition period from traditional pricing models to mixed or full subscription models. They'll also struggle to be able to identify pivotal moments when changes need to be made.

Establishing processes to track metrics consistently and pull reports that include long-term data will help you measure and stabilize the financial health of your business.

3. Focus on the lifetime value for customer retention

In today's era of fierce competition, customer loyalty is hard-won. But the very nature of the subscription model gives you a head start in the race, as it's the foundation of a recurring customer relationship.

Customer satisfaction and retention are the new focus, and lowering subscriber churn is prioritized over acquiring new business — and subscriptions provide opportunities for ongoing upselling and cross-selling to organically grow the business. Additionally, new customers oftentimes initially come by word-of-mouth, so keeping existing customers engaged and recognizing the value of their investment is the primary factor for business growth.

To provide the most customer value in the long run, CFOs must identify which financial levers optimize the value of goods and services in the same way they do in the traditional sales model. From there, finance chiefs are better positioned to establish effective pricing strategies and contract terms, which lays the groundwork for the ultimate prize: long-lasting and mutually beneficial customer relationships.