How deferred income affects your business’s financial health

Published Monday 11 August 2025

Table of Contents:

• What is deferred income?
• Why deferred income matters for your business
• How deferred income works
• Deferred income in accounting and on your balance sheet
• How to manage deferred income effectively
• How to defer income with confidence
• Take control of deferred income with Xero
• FAQs on deferred income

Key Takeaways

• Deferred income is money received before you deliver a product or service.
• It’s recorded as a liability because you still owe the customer.
• Correctly handling deferred income helps your accounts stay accurate and compliant.
• Recognise income gradually as you deliver work or services.
• Using accounting software like Xero can simplify managing deferred income.

What is deferred income?

Deferred income is money your business receives upfront before you deliver a product or service. It’s also called unearned or deferred revenue.

A payment counts as deferred income if it meets these conditions:

• You receive the money before finishing the work or delivering the product.
• You still owe something to the customer in the future.
• Your business regularly deals with these kinds of payments, such as retainers or pre-orders.

If these are true, record the payment as deferred income in your accounts.

Is deferred income an asset or liability?

Deferred income is a liability – not an asset.

That’s because you haven’t earned the money yet — you still owe a product, service, or a refund.

Only after you’ve completed your work can you record it as revenue.

Why deferred income matters for your business

Handling deferred income correctly is vital for small businesses:

• Accurate financial reporting: Income should be recorded when earned, not when received. This gives a true picture of business performance. Learn more about recognising revenue.
• Compliance with UK accounting standards: Most UK businesses follow accrual accounting principles, which requires income recognition only after delivery. Following standards keeps your accounts legal, audit-ready, and trusted. Learn more about UK accounting standards and HMRC’s deferred income guidelines.
• Tax implications: Under accrual accounting, you don’t pay tax on deferred income until it’s recognised as revenue. Recording income too early risks overpaying tax and hurting your cash flow.
• Better decision-making: Recognising income too soon can lead to overestimating profits, causing poor spending and growth choices.

How deferred income works

Here’s how a deferred income liability works, how it turns into earned income over time, and how it differs from accrued income

Deferred income as a liability

When a customer pays in advance, you can’t recognise that money as income right away. You still owe them the product or service they paid for.

Until you fulfil that obligation, the payment is recorded as a liability on your balance sheet under “deferred income” or “unearned revenue.” Once the service is delivered or the product is shipped, you gradually move that amount into your income statement as earned revenue.

The transition from deferred revenue to earned revenue

You don’t need to wait until everything is delivered to start recognising income. Instead, you can recognise revenue gradually as you meet your obligations.

For example, if a client pays £30,000 upfront for a six-month construction project, it may be appropriate to recognise £5,000 in income each month. That amount is deducted from your deferred income and added to earned revenue. This keeps your financial statements aligned with what’s been delivered and what’s still outstanding.

Deferred income vs accrued income

It’s easy to confuse deferred income with accrued income, but they describe opposite situations.

• Deferred income is money you receive before delivering the product or service.
• Accrued income is revenue you’ve earned but haven’t been paid for yet — like invoicing after completing a project.

Accrued income is considered an asset, because it represents money owed to you. Both concepts tie into the accrual basis of accounting, where revenue is recognised when it’s earned, not when payment is received.

Here’s a more detailed guide to deferred income vs accrued income.

Deferred income in accounting and on your balance sheet

Here’s how deferred income works in your accounts:

• initial recording: when you get an advance payment, record it as deferred income
• balance sheet: deferred income appears as a liability.
• revenue recognition: as you deliver goods or services, move the correct amount from deferred income to revenue. For example, if you’ve delivered half the service, you recognise half the income.
• income statement: once recognised, income appears on your profit and loss statement.

How to manage deferred income effectively

Managing deferred income doesn’t have to be complicated. Here are four practical steps to stay in control:

1. Track upfront payments carefully

Keep clear records of when payments are received and what they’re for. This avoids confusion later – whether for your team, your customers, or your accountant.

Record deferred income in a dedicated liability account to keep it organised and make it easier to recognise revenue accurately when the time comes.

2. Recognise revenue in phases

Convert deferred income into earned revenue gradually as you deliver what’s been promised.

If the schedule is time-based, this can often be automated. For example, if you sell a 12-month subscription for £120, you’d recognise £10 as revenue each month.

You can also recognise revenue based on progress. For instance, in a web design project where 25% of the website is built, you can recognise 25% of the total payment. This usually requires more manual input, as you’ll need to confirm and sign off when each milestone is hit.

3. Adjust journal entries regularly

Make sure you move deferred revenue across to earned revenue regularly—monthly or quarterly usually works, depending on your business.

Rather than updating things every time a service is delivered, many businesses schedule time at the end of each period to make these adjustments. This helps ensure your financial records stay up to date. Learn more about keeping company records.

4. Use accounting software for automation

Accounting software can streamline how you manage deferred income.

For example, Xero can automate the process by recording advance payments, scheduling recurring revenue recognition, and updating journal entries. This reduces manual work and lowers the risk of errors.

How to defer income with confidence

Deferring income is a normal part of doing business. Here are some tips to protect yourself and your customer relationships when receiving payments in advance.

1. Create clear contracts

Written agreements protect both you and your customers.

Be specific about how much the customer is paying, what they are paying for, when it will be delivered, and what your refund policy is. Avoid ambiguity – a well-written contract helps avoid disputes and simplifies resolution if problems arise.

2. Communicate proactively with customers

Keep customers in the loop about the status of their order.

Even if there’s an unexpected delay, it’s better to be upfront so customers know what’s happening. While it might feel uncomfortable, transparency builds trust and shows you’re taking action.

3. Align with accounting standards

Following proper accounting standards helps you stay compliant with tax laws and regulations.

If you’re unsure about how to record deferred income correctly, your accountant can advise on the best approach for your business.

Take control of deferred income with Xero

Managing deferred income isn’t just for bookkeeping purposes. It’s an important process that gives you a clearer view of your financial position – helping you make better decisions, manage cash flow, and stay compliant with local laws.

Using tools like Xero makes it easier to track payments, automate revenue recognition, and post the correct double entries – moving income from your deferred income account into revenue as work is delivered.

Ready to streamline your deferred income tracking? Try Xero for free and see how our intuitive accounting software can help you manage your finances with confidence.

FAQs on deferred income

Here are some of the most common questions small business owners ask about deferred income.

How is deferred income different from accounts receivable?

Deferred income is money you've received in advance for work you haven't done yet. Accounts receivable is the opposite – it's money you're owed for work you've already completed.

When should a business recognise deferred income as revenue?

Recognise deferred income as revenue once you’ve delivered the product or service that was paid for in advance – either in full or in parts.

Does deferred income affect business taxes?

Yes. Even though you might physically hold the money, it isn’t recognised as revenue yet – so it isn’t taxed. If you recognise income too early, you could increase your taxable profits and pay more tax to HMRC than necessary.

Can deferred income be refunded to customers?

Yes. If, for any reason, you can’t deliver what was agreed, the customer may be entitled to a full or partial refund.

How long can you defer income on the balance sheet for?

Income can stay deferred for as long as the product or service hasn’t been delivered. There’s no fixed time limit – for example, if a project faces repeated delays, the income remains deferred until it’s earned.