Why do people get nervous when a company's earnings fluctuate? People tend to believe that those in charge of a company have some degree of control. The company needs to set its budget and plans according to the revenues that will be taken in. If a company can not predict its revenues with some degree of accuracy how can it possibly plan for its future? If the management of a company can not make an accurate forecast of its earnings how can investors? When their are unexpected spikes (in either direction) in revenues it shows that managements planning is not as good as it could be.Why is it a given that companies need some flexibility in when they book revenue, to make people less nervous?Companies are given a little bit of flexibility as to when they book revenues because the way businesses earn revenues are different. It's easy to see that a retailer such as Walmart should book revenues at the point of the sale, when the payment is made and the sale is complete. Now, a road construction company that is working on a three year project with payment dispursed throught the time period is a different story.The Realization Principle (A.K.A. Recognition Principle) requires that revenue be recognized at the time, but not before, it is earned. This can get pretty fuzzy sometimes. Just because someone pays you doesn't mean you've earned it yet (unearned revenue/deposits/retainers). Also, just because you haven't been paid yet doesn't mean you haven't earned it (sale/services on credit).Typically a sale/service is booked as revenue when the company has earned the right to payment, whether they receive payment or not.
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