Ok, now for some boring accounting stuff. Red Hat (RHAT) recently restated its financials. Its auditor, PWC, suggested that it change its revenue recognition policy. According to a CBS Marketwatch article:
Under the accounting method used in the past, the company would recognize a full month’s revenue from a subscription agreement, even if a deal was sealed in the middle of the month, for example.
The effect of the accounting change is to defer a portion of the revenue that had previously been recorded during the month that the subscription started to the end of the contract.
So what it comes down to is a timing issue. In the example above, a full month of revenue gets recognized even only if the customer signed in the middle of the month. I don’t really think that this in and of itself caused such a huge selloff in the company. One could argue that the company is overvalued at a $2.8 billion market cap and a 20.5 TTM revenue multiple.
Anyway, I checked around with my portfolio companies which sell hosted software and it seems that we are taking a conservative approach by recognizing a set up fee in the month that we sign a deal and do the work and then begin recognizing the subscription revenue the following month. Anyway, while a boring and mundane issue, I believe this will impact a number of other companies in terms of revenue recognition. My general rule of thumb is to always have portfolio companies prepare for success – this also includes making sure our accounting is conservative and inline with best practices.