What is deferred income and how does it impact your small business cash flow?

Published January 7 2026

Table of contents

• What is deferred income?
• How deferred income affects cash flow
• How to account for deferred income
• Examples of deferred income
• Deferred income vs accrued income and accounts receivable
• Manage deferred income with Xero
• FAQs on deferred income

Key takeaways

• Deferred income is money you’ve received for work or goods you haven’t delivered yet. You need to categorise deferred income correctly for tax purposes – recognise it as revenue only once you have delivered your products or services – so you pay the right amount of tax.
• Deferred income is an injection of cash into your business, but you should make sure you’re reserving enough money to fund the goods and services you’re yet to deliver – this helps you avoid a cash flow gap.
• There are lots of different ways to defer income. You can recognise it as revenue in stages, as goods and services are delivered. Modern accounting software can automate this process for you.

What is deferred income?

Deferred income (sometimes called unearned revenue) refers to the money you’ve received for goods or services you haven’t delivered yet. For a plumber, this might be an upfront invoice payment for work they’ve carried out over 3 months. For a subscription-based service, this could mean a single, upfront annual payment for items or services delivered throughout the year.

Changes to the way you account for deferred income on your balance sheet

As part of UK generally accepted accounting practice (UK GAAP) and recently-updated revenue recognition rules, money your business receives for goods or services it hasn't yet delivered should only be recognised as revenue once control of the goods or services has been transferred.

Previously, revenue was recognised based on when the risks and rewards of a purchase were transferred to a buyer. The key change here is a new, five step revenue recognition model, that sets out how to handle contracts, bundling services, allocating payment to specific items and services, and recognising revenue at different points in time. These changes to the revenue recognition rules will come into effect from 1 January 2026.

So, for the plumber, revenue from this job should only be recognised once the plumber has performed the tasks and fulfilled their contractual obligations

How deferred income affects cash flow

Deferred income has a positive effect on your cash flow, but you need to manage it sensibly to make sure you can deliver the products or services the deferred income payment represents.

Receiving deferred income means an influx of cash into your business. You can use this cash to pay staff, buy stock, or invest elsewhere in your business. But because the work is still outstanding, you need to make sure you have the funds to perform and deliver the work at a later date. Spend deferred income too quickly, and you might not be able to cover the cost of delivering the work.

When you receive deferred income, you categorised it as a liability on your balance sheet because you still owe the customer products or services. But once you deliver these, you can recognise the money as revenue.

How to account for deferred income

Here’s what to do when you get an upfront payment from a client or customer.

• Record it as deferred income in your accounting software. It’s important not to recognise it as revenue until you’ve actually delivered the goods and services. For now, record it as a liability on your balance sheet.
• Once part or all of the service or products have been delivered, adjust the journal entries and move this income across to revenue. You don’t have to do this all at once – you can move 50% of the income across when you deliver half the work, for example.
• Check your profit and loss statement to make sure that once revenue is recognised, it’s recorded there.

You might find you need to unbundle some products and services in your contracts and invoices so you can recognise the related chunks of revenue at different points. For example, if the plumber delivering work over 3 months unbundles their services in their contracts, they could then recognise the revenue in three equal chunks each month as they deliver the work. Once recognised, the revenue appears on the plumber’s profit and loss statement.

Ask an accountant for help if you need to. You can find one in Xero’s advisor directory.

Examples of deferred income

Deferred income looks different across industries and sales. Here are some examples.

• A software provider allows customers to pay annually for a year’s subscription. Customers pay £240 per year in a single lump sum. Each month, £20 moves from a liability (deferred income) to revenue on the balance sheet.
• An architect charges in full for a 6month project upfront. At month 3, the architect has delivered half the work, so they can move 50% of the income to revenue. At month 6, the remaining half becomes revenue too.
• A hotel takes payment for a stay booked 2 months in advance. Once the customers have visited, vacated the room, and checked out, the hotel recognises the deferred income as revenue because the customers’ stay is complete.

Deferred income vs accrued income and accounts receivable

Deferred and accrued income are almost opposites. While deferred income refers to a payment made upfront, for goods or services yet to be delivered, accrued income is where goods and services have been carried out but payment hasn’t been received yet. Accrued income appears as a current asset on the balance sheet because it’s due to be received in the future.

Accounts receivable is money owed to your business for goods and services. Accrued income becomes accounts receivable once you’ve invoiced a customer for it.

Manage deferred income with Xero

It’s easy to overlook deferred income. But Xero accounting software tracks your payments to help you categorise and recognise it correctly so it aligns with UK accounting standards.

Xero also automates the process of recognising revenue and posting journal entries, saving you the admin and giving you a better view of your business’s financial position and available cash. That helps you make more informed decisions about spending and saving to keep your cash flowing.

Try Xero for free

FAQs on deferred income

Here are answers to some common questions about deferred income.

What’s the risk of deferred income?

The main risk is that if you use deferred income to fund your business without reserving enough cash for keeping your business running and delivering the work, you could face a cash-flow gap. But as long as you record deferred income correctly and keep cash to cover your costs, things should run smoothly. You can always create a cash flow projection to check you have enough for the months ahead.

How does deferred income affect my tax?

You don’t pay tax on deferred income until it’s recognised as revenue. This could mean that work charged in one tax year – work that isn’t carried out straight away – is taxed in the new tax year. If you record the income as revenue too early, you could end up paying too much tax.