Money Received Is Not Money Earned, and Your Bank Balance Does Not Know the Difference
· 7 min read · Written by Faceela Research & Editorial Team
Reviewed by Ahmed Hassan Algammal — Founder and Enterprise Systems Consultant
January is the best month most professional firms have. The annual retainers go out in one run, the receipts land over the following weeks, and for a short period the bank balance says something very encouraging about the business.
It is saying nothing of the kind. At that moment the firm has done none of the work. What it holds is a year of obligations with the money already attached — which is the least comfortable position a service business can be in, and the one that feels the best.
The distinction is between money received and money earned, and it is not an accounting nicety. It is the reason a firm can have a strong year in the bank and a weak one in reality, and find out about it in the following January, all at once.
The receipt creates an obligation, not a result
Think about what actually happened when the retainer was paid.
The client transferred cash. In exchange, the firm took on a commitment to deliver something over the coming twelve months — advice, filings, availability, whatever the engagement letter says. Until that delivery happens, the money is not the firm's in any meaningful sense. It has been received against a promise that has not yet been kept.
An accountant will recognise this immediately: it belongs on the wrong side of the balance sheet until it is earned, and it is released to revenue as the work is delivered. Firms that prepare their own accounts properly do exactly that.
But here is the part that gets missed, and it is the part that costs money. In most firms the release to revenue is done on the calendar — a twelfth a month, because the retainer is annual and there are twelve months. That is not recognising revenue as work is delivered. That is recognising revenue as time passes, which is a different thing entirely, and it means the accounts are as blind to consumption as the bank statement was.
One retainer year
Three lines that never move together
1. The invoice is raised
Cash in
The whole year, on one document.
Revenue earned
None. Nothing has been done yet.
Work delivered
None. The engagement has not started.
2. The payment lands
Cash in
Banked, and indistinguishable from every other receipt in the account.
Revenue earned
Still none earned — but the obligation to deliver now exists and sits on the wrong side of the balance sheet if nobody puts it there.
Work delivered
The first meetings. Nobody is counting them.
3. The first quarter
Cash in
Unchanged. It has already arrived.
Revenue earned
Released on the calendar, if it is being released at all — a twelfth a month, regardless of what was done.
Work delivered
Heavy. Set-up, onboarding, the year's arguments, all front-loaded.
4. Around the middle
Cash in
Unchanged.
Revenue earned
About half, by the calendar.
Work delivered
On some engagements, all of it. The fee has been consumed and the year has not.
5. The quiet months
Cash in
Unchanged.
Revenue earned
Still releasing, still on the calendar.
Work delivered
On other engagements, almost nothing — and nobody records not being asked.
6. Renewal
Cash in
The conversation. Usually the same number as last year.
Revenue earned
The balance released, earned or not.
Work delivered
Unknown, because for twelve months nothing counted it.
Only one of the three is visible without being measured
The bank balance is a fact and arrives by itself. Revenue earned is a policy somebody has to apply. Work delivered is a measurement somebody has to take. A firm that takes neither has one line where it needs three, and it renews on it.
The retainer that was consumed by March
Every firm has this client, and can usually name them without looking.
The engagement was priced on an expectation of the year's work. By the end of the first quarter the year's work had been done — the set-up, the clean-up, the thing that turned out to be much worse than anyone said in the scoping call, the questions that came three at a time because the client had been storing them up.
From April, the firm serves that client for free. Not as a decision, and usually not as a known fact. The work keeps arriving, it keeps being done, and nothing anywhere raises its hand — because the fee was banked in January, the revenue is being released a twelfth a month exactly as planned, and the calendar has no opinion about how much was consumed.
The cost of this is not the free work. The cost is that in December, when the renewal is discussed, the firm has no evidence that anything unusual happened. So it renews at the same number, and buys the same year again.
The retainer nobody touched
The opposite client is quieter and, over a portfolio, does more damage.
They paid, and then they were busy. Three interactions in the year, none of them heavy. The firm delivered everything it was asked for, and it was asked for very little.
This looks like the good outcome and it is not, for two reasons. The first is that the client is entirely capable of asking, in month eleven, what exactly they have been paying for — and a firm that cannot answer with a record of delivery is negotiating from nothing. The second is that a portfolio of these teaches a firm the wrong lesson about its own pricing. If a third of the retainers are barely consumed, the firm is not efficient. It is holding fees against work it has not been asked to do, and the ones that get asked for are subsidising the ones that do not.
Both clients renewed at the same price. Neither price had anything behind it.
What the bank shows, and what it actually is
| What is happening | What the bank shows | What it actually is |
|---|---|---|
| The annual retainer is invoiced and paid | A large receipt in one month | Twelve months of obligation, funded in advance |
| An advance is taken against future work | Cash | A liability until the work is delivered |
| The fee is consumed by the end of the first quarter | Nothing changes | Nine months of work about to be given away, unpriced |
| The fee is barely consumed by October | Nothing changes | A renewal conversation the firm cannot evidence |
| VAT falls due on the payment received | Cash you are not free to spend | Money held on behalf of the authority, before the work was done |
| The retainer is renewed at last year's number | A renewal | A price set with no evidence on either side of the table |
Read the middle column downwards. It changes twice in six rows, and both times for a reason that has nothing to do with whether the engagement is going well.
That is the whole problem in one column. The bank statement is the most trusted document in most small firms, it is the one the partners actually look at, and it is silent on every question that decides whether the year was any good.
The tax arrives with the money, the revenue arrives with the work
There is a second, sharper version of the same mismatch, and it catches firms that are otherwise careful.
Where the receipt of payment triggers the date of supply — which is the normal position for an advance or a retainer taken up front, though it turns on how the arrangement is actually structured — the VAT falls due in the period the money arrived. The work has not been done. The revenue has not been earned. The return is due anyway.
So the firm has three different clocks running on one engagement: cash, which arrived in full in January; output tax, which followed the cash; and revenue, which is released over the year. None of them agree with each other, and each one is correct for its own purpose.
That is survivable, and firms survive it every year. What is not survivable is holding those three positions in three different places — the bank in one system, the tax in a spreadsheet, the revenue in a manual journal somebody posts at month end. The reconciliation between them is where the errors live, and it is the reconciliation an FTA audit will ask you to walk through line by line, from the receipt to the return to the revenue account.
None of that is difficult when the three come from the same record. All of it is difficult when they come from three.
What to make a vendor show you
On a live system, on a real retainer, not on slides.
- Invoice an annual retainer and show the money landing somewhere other than revenue, automatically, without a manual journal.
- Release that balance to revenue as work is delivered — not a twelfth a month — and show which delivery released it.
- Show, in month seven, how much of one retainer has been consumed and how much remains.
- Produce a list of retainers over-consumed and a list under-consumed, side by side, before the renewal season starts.
- Show the tax position on the receipt and the revenue position on the delivery, on the same engagement, reconciling.
- Show what was actually delivered against one retainer over twelve months, as a document you could put in front of the client.
- Take a retainer that ran out and show what the system does when the next piece of work arrives against it.
Item 2 decides it. Almost every system can defer income and release it on a schedule — that is a straight-line calculation and it has been in accounting software for thirty years. Releasing it against delivered work is a different capability, because it requires the system to know what delivery is on this engagement, and that is the part vendors skip.
Item 7 is the honest one. What most systems do is nothing, silently, which is precisely how a fee gets consumed in March and served until December.
The short version
Cash received and revenue earned are two different facts about the same engagement, and only one of them appears in the bank.
Releasing deferred income on the calendar is not recognising revenue as work is delivered. It is recognising revenue as time passes, and it leaves a firm exactly as blind to consumption as it was before — which is why the retainer that ran out in March and the retainer nobody used both renew at the same number.
The tax makes a third clock, and it starts with the cash rather than with the work. Three clocks on one engagement is manageable. Three clocks in three systems is where the errors live.
What this looks like when the engagement, the delivery record and the ledger are one thing is on the professional and business services page; the system is ServX. The neighbouring pieces are unbilled WIP in professional services, client profitability, and — because the pricing model is what put the money in the bank early in the first place — fixed fee versus time and materials. If you want an arithmetic view of what the current arrangement is costing before anybody talks about software, the cost of chaos calculator does it from your own figures.