The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (
) -- In this article, we'll take a look at the "Deferred Revenues" line of a company's balance sheet and how investors can use it to get a glimpse into the company's future.
So, what are "Deferred Revenues"? They are a line item in a company's balance sheet, generally under the short-term liabilities section, and often under long-term liabilities as well.
Deferred revenues are received cash deposits that a company has collected, but not yet reported as revenue on the income statement.
As they are reported as revenue in subsequent quarters (i.e., "amortized"), the amounts are deducted from the deferred revenue account. Amounts expected to be reported as revenue within the next 12 months fall under the short-term category, while amounts that will be amortized farther out fall into long-term deferred revenues.
Not all businesses have a deferred revenues line. The most common sort of companies utilizing deferred revenues are service-oriented firms, where customers pay up front for a term of service. This cash goes directly into the company's coffers, but the firm will usually recognize revenue evenly over the term of the service.
How this works is best illustrated by an example. Let's use a subscription example because it is easy for most folks to relate to.
Fortunately, we have a good example currently in Magic Formula Investing (MFI) with
, which publishes popular periodicals like
Better Homes and Gardens
Ladies Home Journal
Better Homes and Gardens
can opt for a one-year subscription, or a longer, multiyear subscription, which usually offers a lower price per issue.
When I choose the one-year subscription (say, for $24, or $2 per issue), I send a check to Meredith. The company adds this check to the cash account of its balance sheet and also the short-term deferred revenues line, because all of my cash will be recorded as revenue within 12 months. Then, each month, Meredith will move $2 of my deposit out of deferred revenues and report it as revenue on the income statement.
The effect is similar for a multiyear deal. In this case, say I spend $36 for three years ($1/issue). In this case, $12 of my deposit goes into the short-term deferred revenues line, while the remaining $24 goes into long-term deferred revenues (because it will not be recorded until after 12 months). Each month, $1 from short-term is recorded as revenue, and $1 from long-term gets moved into short-term!
The great thing about deferred revenues is that they often give you a glimpse into the forward trends a company is experiencing. For example, here are Meredith's short (ST) and long-term (LT) deferred subscription revenues for the past five years:
- Fiscal 2010: ST = $159m, LT = $131m
- Fiscal 2009: ST = $171m, LT = $148m
- Fiscal 2008: ST = $175m, LT = $158m
- Fiscal 2007: ST = $191m, LT = $168m
- Fiscal 2006: ST = $200m, LT = $169m
Clearly, the trend is poor. That is five consecutive years that subscriptions have been declining. Worse, the rate of decline is accelerating. In 2010, total deferred subscription sales fell 9%, well above the roughly approximate 5% decline seen in prior years. From this, we can forecast that reported subscription revenues over the next year will be down approximately 7%, and potentially even higher in subsequent years.
This is why deferred revenues, despite being a "liability" on the balance sheet, are something we actually want to see going up, not down!
At the time of publication, Alexander had no positions in any stocks discussed in this article.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.