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From software implementation to consulting, there are plenty of sources of service revenue. Understanding the proportion of service revenue to total sales can help a business understand its financial health and uncover investment opportunities.
What is Service Revenue?
Service revenue is exactly what it sounds like: The amount of a company’s net income derived from the services it provides.
This form of payment is separate from product sales, as it doesn’t involve the customer purchasing a physical or digital good. It does not include interest payments, gains or losses on investments, or revenue earned from product shipments.
Common examples of service revenue include:
- Consulting fees
- Software implementation
- Bookkeeping and tax services
- Web design work
- Marketing services
- A subscription service with a monthly retainer
For service-based businesses (e.g., agencies, consulting firms), most or all of the total revenue earned will fall into the “service revenue” category.
Companies that sell products (e.g., ecommerce, SaaS, manufacturing) typically have a mix of service and product revenues. In these cases, it helps to know what percentage of the total revenue comes from these types of revenue streams.
- Business service revenue
- Service-based revenue
Types of Service Revenues
There are two primary types of service revenue accounts: operating and non-operating revenue.
Understanding their differences and when to record them on financial statements is essential for accurately tracking and reporting your company’s performance.
Operating revenue (also known as operating income) is the primary source of income generated by a company’s core business activities. This type of service revenue is directly tied to the provision of services that the company specializes in and is essential for its day-to-day operations.
Operating revenue serves as a critical indicator of a company’s financial performance, as it reflects the effectiveness of the business model and the company’s ability to generate income from its core services.
Some examples of operating service revenues include:
- Fees earned by an accounting firm for providing tax preparation and auditing services
- Revenue generated by a marketing agency through the management of clients’ advertising campaigns
- Income earned by an IT consulting firm for providing technology solutions and support
Monitoring operating revenue trends can help business owners identify growth and improvement areas and assess the success of new service offerings or changes in pricing strategy.
Non-operating revenue, on the other hand, refers to income derived from sources outside a company’s core business activities. While this type of revenue may not be as directly tied to the sales of services, it still contributes to a company’s overall financial health.
Non-operating revenues are typically more sporadic and less predictable than operating revenues since they are not generated through the company’s main line of business.
Some examples of non-operating service revenues include:
- Rent income earned from leasing out a portion of a company’s office space
- Royalties earned from licensing a company’s intellectual property to another business
- Gains on the sale of long-term investments or assets, such as real estate or equipment
- Currency exchange gains
While non-operating revenue can provide an additional source of income, business owners need to recognize that these revenues may not be as sustainable or reliable as operating revenues.
As such, relying too heavily on non-operating revenue models creates financial instability and makes it more challenging to assess the true efficacy of the company’s core services.
Using the Accrual Accounting Method for Service Revenues
Accrual basis accounting is an accounting method in which revenues and expenses are accounted for when earned rather than when the organization receives a payment.
The accrual accounting approach allows service-based businesses to recognize service revenue more accurately by matching it with the corresponding cost of providing services to customers.
Under this method of accounting, service revenue recognition happens as soon as the work has been completed and billed, even if payments are released in different accounting periods.
The balance sheet includes service revenues as accounts receivable for services rendered (also called “accounts payable”). This amount is usually shown separately from other accounts receivable because it is not considered cash.
How to Record Service Revenue on an Income Statement
To make an accounting journal entry for service revenues, you’ll need to follow these key steps:
1. Identify the revenue-generating event
Recognize when a service has been provided, even if the payment has not yet been received.
This event triggers the entry for service revenue in your accounting records.
2. Record the service revenue
The accrual method uses a double-entry system, creating an entry in your general ledger to account for the service revenue.
Typically, you will debit (increase) an accounts receivable account and credit (increase) a service revenue account. This process acknowledges that the service has been provided, and your company is now owed payment.
- Debit Accounts Receivable: $1,000
- Credit Service Revenue: $1,000
3. Record the payment
Record the cash receipt in your accounting records when the customer pays for the service. This will involve debiting (increasing) your cash account and crediting (decreasing) your accounts receivable account.
- Debit Cash: $1,000
- Credit Accounts Receivable: $1,000
4. Monitor outstanding receivables.
Regularly review your accounts receivable balances to identify any outstanding payments. This can help you manage cash flow and ensure the timely collection of service revenues.
5. Adjust for uncollectible accounts.
In some cases, you may not be able to collect the full amount of service revenue recorded as accounts receivable.
In such cases, you’ll need to adjust your accounting records to reflect the uncollectible amount. This typically involves debiting (increasing) an allowance for doubtful accounts and crediting (decreasing) the accounts receivable account.
- Debit Allowance for Doubtful Accounts: $200
- Credit Accounts Receivable: $200
Service Revenue Example
Here is a sample income statement for a fictional service company:
|Income Statement||Amount ($)|
|Salaries and Wages||$60,000|
This sample income statement overviews the business’s financial performance, including the breakdown of revenues and expenses.
The company has a total revenue of $125,000, comprised of $120,000 in service revenue and $5,000 in non-operating revenue. After accounting for all the expenses, the net income amounts to $31,000, indicating a profitable business.
Challenges in Calculating Service Revenue
Calculating service revenue isn’t always straightforward. Different types of services can involve various complexities in terms of the methods used to measure and recognize service revenue.
Accounting for Deferred Revenue
Deferred revenue (unearned revenue) represents payments received in advance for services that have not yet been provided.
The accounting team can only recognize revenue once the service has been delivered in both cash and accrual accounting systems. If payments are received in advance, companies need to carefully track and account for deferred payments, adjusting their financial records when services are provided and revenue is earned.
Failure to handle deferred revenue properly can result in overstated revenue figures and inaccurate financial statements.
Manual Journal Entries
Relying on manual processes for recording revenue can be time-consuming and prone to errors.
Input mistakes, calculation errors, or inconsistencies in record-keeping can lead to inaccuracies in service revenue calculations.
Revenue recognition automation helps businesses improve audit visibility and reduce manual labor, allowing finance teams to focus on higher-value tasks.
Tracking Changes to Revenue Accounts
Businesses encounter numerous changes affecting their service or project revenue, such as pricing adjustments, changes in customer contracts, or modifications in service offerings.
When every service revenue journal entry is subject to change, adjusting any changes and ensuring accuracy can take extra time.
Understanding Cash Flow vs. Service Revenue
For accounting purposes, service revenue is separate from the actual cash receipt. This distinction sometimes confuses businesses trying to understand their financial health.
Service revenue provides insight into the company’s performance based on services rendered, but it does not directly indicate the cash available for business operations.
How to Grow Service Revenue
Service revenue can be a highly profitable revenue stream, even for businesses that sell physical or software products.
Here is a quick list of ways you can grow your service revenue faster:
- Offer services that help customers adopt your product faster, such as phased implementation or personalized company training.
- Upsell and cross-sell complementary services to existing clients, increasing the value they receive from your business.
- Provide exceptional customer service to encourage repeat business and positive word-of-mouth referrals.
- Bundle services to appeal to different customer segments and needs.
- Develop strategic partnerships with complementary businesses to expand your reach and offer more comprehensive solutions to clients.
- Offer flexible pricing models, which can increase your conversion rate.
- Solicit and act upon customer feedback to improve and address any concerns, fostering long-term client relationships.
Automating Service Revenue Accounting
About 75% of accounting tasks can be automated with software, saving businesses hours per day.
Service-specific accounting platforms typically provide features such as invoicing, expense tracking, accounts receivable management, financial reporting, and integration with other business tools like CRM, CPQ software, time-tracking tools, and project management systems.
An added benefit of adding a software element to the accounting process is that accountants won’t need to worry about the service revenue formula, deferred revenue, or other accounting complexities.
Software solutions can help businesses stay compliant, recognize revenue on-time, and give them better visibility into the financial health of their business.
People Also Ask
What is a service revenue example?
Here is a quick example of service revenue:
Company A is a SaaS provider that charges customers a monthly subscription fee. Since its product often requires custom configuration, it offers ongoing support for teams that use it.
Any time a customer needs a feature that needs custom coding and IT support, Company A bills them an hourly rate for the work.
The revenue from this service is kept separate from the recurring subscription revenue, even though it comes from the same client.
Is service revenue an asset or liability?
On the balance sheet, service revenue is recorded as accounts receivable. Accounts receivable is considered an asset, meaning service revenue is an asset to the company.
If a customer pays for services in advance, then the payment amount is recorded as unearned revenue and it is reported as a liability on the balance sheet.
Does service revenue affect owner’s equity?
Service revenue is part of the operating activities, affecting the retained earnings in the balance sheet. The net income generated from service revenue impacts the owner’s equity positively or negatively, depending on profit margins.