Remember that accounting training you got when you went into marketing? Probably didn’t happen, right? 😏 Even though most marketers don’t always get the training they need, it is important that everyone responsible for significant marketing spend understands a few key accounting principles, and how those principles apply to their marketing budgets.
This blog introduces five important pieces of information you need to know before you create and spend your budget: cash-basis accounting, accrual-based accounting, expense recognition, roll-forward, and use-or-lose-it.
If you understand these concepts, you will protect your budget, yourself, your team, and your company, from the unwanted consequences of major over- and underspend in your marketing budget. 🤓
Cash-based vs accrual-based accounting
Most articles you will read about these two different types of accounting focus on revenue and expenses. For most marketers, the focus is primarily on expenses alone, so that will be our focus. Given that, what does it even mean to account for an expense? Investopedia describes accounting as, “the practice of recording financial transactions pertaining to a business.” 🤷
There is a parenthetical phrase that I would add to make this more useful: accounting is the practice of recording financial transactions pertaining to a business, in the most informative way possible. Accounting helps explain what has happened financially in the business, so it needs to be comprehensible and clear.
There are two high-level approaches to accounting, each described below with their pros and cons.
Cash-based accounting records expenses when they are paid. This is normally not the most informative method of accounting. 👎
In cash-based accounting, the relevant expense hits the financial books at the time the funds leave the company bank account. In some ways this seems intuitive. It is how most of us are used to managing our personal finances. And if you’re running a lemonade stand, it might still be a good approach! But for most companies, it’s not particularly useful. Why? because there is often a separation in time between the cash outlay and the activity that generated the cash outlay. And this approach builds that difference right into the company’s books. If accounting is supposed to tell the story of the business, this approach obscures the real story. Because the date a bill happens to be paid is hard to predict, doing cash-based accounting creates a narrowly accurate, but somewhat arbitrary record of the business.
While a business may well want to pay for something 6 months after they received it, it doesn’t want to account for it that late, because it’s just too difficult to keep track of what that expense was for, when you consider the large number of diverse expenses the business incurs over time.
Finally, the gold-standards for business accounting - GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) - do not support cash-based accounting, and most companies don’t want to report their accounts in non-standard ways.
Accrual-based accounting uses the notion of value to account for expenses. This method is required for GAAP and IFRS accounting. In accrual-based accounting, marketing costs may be recorded differently depending on what they are. Certain costs, like printing jobs, will normally be recognized upon invoice. On the other hand, recognition of event expenses will often be deferred until the date of the event, and all recognized on the same day as the event.
Why does it make sense to recognize expenses on different dates? The idea is to make the state of the business clearer to observers (executives, investors, auditors, etc). By aligning expense recognition of event costs with the date of the expense itself, it is easier to discern how much the event cost. If all the expenses in the run up to the event were recognized as they came in, it would be almost impossible to discern from an accounting system what the event actually cost.
So in accrual accounting, there is an association -- a matching -- between when an expense is recognized in the company accounts, and when the company receives value. Finance teams try to adopt a consistent approach about when the various types of expenses are recognized for their company, but companies have some latitude about how they operate as long as they are consistent. So as marketers move from company to company throughout their careers, they need to understand how each new company does things. It’s important for marketers to understand the timing of expense recognition within their company so that they can plan accurately.
ACME wants to run an ad campaign on TV. ACME outsources 100% of the ad production costs ($500,000) to AdAgencyCo. It purchases a $1,000,000 mediabuy on a TV station. ACME receives the invoices for the ad production and the media buy on the same day. That date happens to be after the production is complete, but 2 months before the ads will air on TV. The $500,000 production costs are recognized when the invoices are received, because the value received by the company is the finished ad. So the bills for the ad production must be recognized when production is completed, regardless of whether - or when - the ad airs. The $1,000,000 mediabuy is recognized in the books two months later, when the ad is aired. It is important for the marketers at ACME to understand when the costs for their campaign will be recognized, otherwise they might find expenses hitting their budget in unexpected time frames (Note: this is not the only way the investment can be accounted for in an accruals based approach, but it is one valid method that is provided as an example in GAAP guidance to help illuminate time-based recognition of different marketing costs).
Sometimes an accounting team might accrue an expense before an invoice is even received. It might do this if there is a highly predictable billing cycle and well-established value for a given bill. For example, many companies have contracts with SaaS companies that invoice on a monthly basis. The SaaS contract may call for payment of $1,000 on the 1st of every month. Accounting may well decide to accrue the $1,000 expense even if the invoice hasn’t arrived by the first of a given month. This makes sense, because there’s a legally binding contract in place that stipulates a $1,000 expense every month. If nobody canceled the service, there’s surely a bill coming: it’s common sense to account for it.
This method of accounting makes business finances more readable, traceable, and understandable for everyone, because it shows expenses as being accounted for in the same time period as the value received. That matching principle is a cornerstone of good accounting.
Cash Accounting - one method, simple, but not that informative
- Service delivered → invoice received → invoice paid/expense recorded
Accrual Accounting - various valid methods, more complex, expense tied to value
- Service delivered → invoice received + value received + expense recognized → invoice paid
- Invoice received → service delivered + value received + expense recognized → invoice paid
- Service delivered + value received + expense recognized → invoice received → invoice paid
👏 WHY 👏 DOES 👏 THIS 👏 MATTER 👏 TO 👏 MARKETING 👏 BUDGETS? 👏
I know, I know. This is not why we became marketers. But it matters a lot. Here’s why: your marketing budget is distributed over time: that could be months or quarters. There is some allocation of funds in the plan that assumes you will spend the budget at a certain rate each time period. Your goal is to spend it down to the last penny (but no more) and to spend it on the most goal-aligned activities you possibly can. If you don’t know how your expenses are being accounted for, then you don’t know what you’ve spent for a given time period’s budget. Look at this treatment of the same expense under cash-based vs accrual accounting
In cash-based accounting, the expense was deducted from the Q3 budget. In accrual accounting, it was deducted from the Q1 budget. For most marketers, the accrual based system makes much more sense: their expenses are accounted for when they are invoiced. This is much easier to plan for and manage in order to manage spending accurately. As a marketer, you should not need to care when the cash has left the company bank account, or what the CFO is doing on the Balance Sheet!
Spotlight: Expense Recognition in Accrual Based Accounting
There is one other critical element of accrual based accounting that is important to familiarize yourself with: when are expenses recognized? Didn’t we just say they’re recognized upon invoice? Not quite - we said they’re accounted for upon recognition of value. It is possible that you might be invoiced for a service, may even pay for a service, before it delivers business value. The most common marketing example of such an instance is events.
Consider the diagram below, where marketing incurs multiple expenses in the run-up to, during, and even shortly after a trade show.
The blue expenses represent those that have been invoiced and paid. The green expenses represent expenses that have not yet been invoiced and/or paid. Under accrual-based accounting, it is possible that 100% of these expenses will be recognized by the company on the day of the event because this is when the company received value for all of the expenses related to the event. From an accounting perspective, that looks like this:
Suddenly we see expenses appearing in what might feel like the wrong quarter again, even under accrual-based accounting. Confusingly, expenses that the marketer knows have been paid may be moved in the company accounts to align with the event date (i.e. when the value was received). In the finance report of expenses, this will normally show as a negative value (e.g. -$50,000) in the time period where the expense was originally paid and a new, equivalent positive value on the date of the event. Nothing has really changed other than the date the company has decided to account for the expense, but you need to know whether and how that impacts your marketing budget - preferably when you create your plan.
It’s important that the marketing team knows when accrued expenses will be recognized so that they know (1) how to budget accurately at the beginning of the year (2) when expenses will be deducted from the budget, no matter when the invoices land.
At a minimum, marketers should be sure to understand how expenses for campaign types that trigger deferred expense recognition - like trade shows - are treated by finance. Failing to do so could lead to significant underspend in certain quarters (i.e. you thought you were accruing event expenses but you weren’t) and significant overspend in others (i.e. all the expenses for an event hit at once, and you thought you’d already paid for them).
Understanding expense treatment for your budget is not just a CMO responsibility - all marketers running campaigns (especially events) and spending the company’s money need to have a keen sense of how their investments are accounted for.
Roll-forward vs Use-it-or-Lose-It
Some companies set a budget for the year, and if not all of the anticipated Q1 budget is spent, the difference is rolled forward into Q2, and so on through the year.
Others operate on what is known as a use-it-or-lose-it basis. If you fall into this camp, the need to understand how expenses are accounted for is even keener. Under use-it-or-lose-it budgets, there are normally soft boundaries between months (e.g. unused budget from January can be rolled into February) but hard boundaries between quarters (e.g. unused Q1 funds are taken back by the company, and the Q2 budget remains unchanged).
Returning to our event example in the previous section, imagine the the total cost of that trade show was $250K. The marketing team anticipated that $150K would come from the Q3 budget and $100K would come from the Q4 budget.
Unfortunately, the entire $250K came from Q4. Under use-it-or-lose-it policy, the $150K underspend in Q3 is taken back by the company, and the Q4 budget has an unexpected additional $150K of closed expenses to fund. That means Q4 needs to be radically replanned at very short notice or the budget will be badly over-spent.
If you work in marketing or marketing ops, you should make sure you’re familiar with the accounting concepts covered in this blog so that you can have a clear understanding of how and when expenses will hit your budget. If you understand these concepts, you will be able to plan and execute more accurately. This will help you and your team ensure you spend your funds promptly, confidently, and on the most important things. ✊👌💪
Dan Faulkner is the CTO of Plannuh. Dan has degrees in speech and language processing and marketing. He got his marketing degree after running research for text-to-speech synthesis research at SpeechWorks (now Nuance) and must have been looking for something easy to do. You can follow him on Twitter and LinkedIn.