The revenue looked strong: steady growth, stable margins, every quarter in line. Then one line in the accounting policy note raised a question, and a closer look showed sales booked before delivery, milestones recognised without completion evidence, and a rush of dispatches in the last week of the year with no cash behind them. In due diligence, the risk is rarely falling revenue. It is overstated revenue.
Revenue recognition in due diligence means testing when, how much and whether a company should have recorded its revenue. Teams review the accounting policy under Ind AS 115 or AS 9, test cut-off around the period end, reconcile sales with GST returns and cash receipts, and remove early or non-recurring revenue from adjusted EBITDA. Because deals are priced on a multiple of EBITDA, small revenue errors can move the price substantially.
Why revenue deserves special attention in due diligence
Revenue is the starting point of every valuation model. It is also the line where management has the most judgement: when control passes, how discounts are estimated, whether a contract has one deliverable or several. That judgement is legitimate, but it can be stretched. Aggressive recognition brings profit forward into the period being sold, and the correction arrives after the buyer has paid for it.
The accounting framework: Ind AS 115 and AS 9
Companies that follow Indian Accounting Standards apply Ind AS 115, Revenue from Contracts with Customers. Other companies, typically unlisted entities below the Ind AS thresholds, continue to apply AS 9, Revenue Recognition, and AS 7, Construction Contracts. Ind AS 115 is built on a five-step model, and each step is a place where judgement, and therefore risk, sits.
| Ind AS 115 step | What it asks | Where it goes wrong |
|---|---|---|
| 1. Identify the contract | Is there an enforceable agreement with a customer who is likely to pay? | Sales to customers with no real ability to pay; side letters |
| 2. Identify performance obligations | What distinct goods or services are promised? | Bundled installation, warranty or support booked up front |
| 3. Determine the price | What consideration is expected, including variable amounts? | Rebates, volume discounts and return rights not estimated |
| 4. Allocate the price | How is the price split across obligations? | Too much allocated to items delivered early |
| 5. Recognise revenue | When is each obligation satisfied: at a point in time or over time? | Recognition before control passes; optimistic percentage of completion |
Where revenue risks often hide
Early booking and weak cut-off
Invoices raised before dispatch or acceptance, or dispatches pushed out in the last days of the year, inflate the period being sold. The tell-tale sign is a sharp spike in last-month sales followed by returns or credit notes in the first weeks of the next period.
Bill-and-hold and channel stuffing
Goods invoiced but held at the seller's warehouse, or excess stock pushed to distributors with extended credit or return rights, create sales that may never convert to cash.
Milestones and percentage of completion
In projects and long-term contracts, revenue recognised over time depends on cost estimates or milestone certification. Missing completion evidence and growing unbilled revenue are warning signs.
Gross versus net (principal versus agent)
A trading or platform business that reports the full transaction value instead of only its commission can show inflated turnover with the same profit. This matters for revenue multiples and growth claims.
Related party and one-off revenue
Sales to group companies, or one-time items such as scrap sales, export incentives or settlement income, may not continue after the deal. See our article on related party transactions in due diligence.
How due diligence tests revenue
- Read the policy and contracts. Compare the accounting policy with the actual terms of key customer contracts: delivery terms, acceptance clauses, return rights, rebates.
- Analyse monthly trends. Look at revenue, gross margin and credit notes month by month. Period-end spikes and margin swings need explanations.
- Test cut-off. Match invoices in the last and first weeks of the period with dispatch records, e-way bills and customer acknowledgements.
- Reconcile with GST data. Reconcile book turnover with GSTR-1, GSTR-3B and e-invoice data. Unexplained gaps are investigated.
- Prove revenue with cash. Trace revenue to collections and review receivable ageing and subsequent receipts. See cash flow vs profit.
- Review post-period credit notes and returns. Large reversals after the year-end usually mean revenue was recognised too early.
- Check customer concentration. Identify dependence on a few customers and confirm contract terms and renewal risk.
- Adjust EBITDA. Carry findings into the quality of earnings analysis as normalisation adjustments.
Worked example: how a revenue finding changes the price
An illustrative manufacturing company reports revenue of ₹120 crore and EBITDA of ₹18 crore. The buyer is offering 8 times EBITDA.
| Finding | Revenue impact | EBITDA impact |
|---|---|---|
| Year-end dispatches returned in April | – ₹4.0 crore | – ₹1.0 crore |
| Year-end volume rebates not provided | – ₹1.2 crore | – ₹1.2 crore |
| One-time export incentive treated as operating income | – | – ₹0.8 crore |
| Adjusted | ₹114.8 crore | ₹15.0 crore |
EBITDA falls by ₹3 crore. At 8 times EBITDA, the enterprise value falls from ₹144 crore to ₹120 crore: a ₹24 crore difference from findings that were each individually small. This is why revenue testing is not a formality.
Red flags in revenue recognition
- A large share of annual sales in the last month or last week of the year.
- Receivables growing faster than revenue, or rising days sales outstanding.
- High credit notes, returns or discounts soon after the period end.
- Growing unbilled revenue or contract assets without matching billing.
- Book turnover that does not reconcile with GST returns.
- Changes in accounting policy or estimates just before the sale process.
- Sales to new or related customers with unusually generous terms.
Checklist for buyers and investors
Frequently asked questions
Why is revenue recognition important in due diligence?
Because revenue drives EBITDA and therefore the deal price. If revenue is booked early, at the wrong amount or without a real transfer of control, the buyer pays a multiple on profits that may reverse after closing. Revenue testing protects the valuation.
Which accounting standard governs revenue recognition in India?
Companies following Ind AS apply Ind AS 115, Revenue from Contracts with Customers, which uses a five-step model. Other companies continue to apply AS 9, Revenue Recognition, and AS 7, Construction Contracts, under the Companies (Accounting Standards) Rules, 2021.
What is revenue cut-off testing?
It checks that sales recorded just before the period end were actually delivered and accepted in that period. Due diligence teams compare invoices, dispatch records, e-way bills and customer acknowledgements around the year-end, and review credit notes and returns in the following weeks.
What is channel stuffing?
Pushing excess stock to distributors near the period end, often with extended credit or return rights, to inflate reported sales. Signs include a spike in last-month sales, rising distributor receivables and high returns or credit notes after the period end.
How is GST data used in revenue due diligence?
Turnover in the books is reconciled with GSTR-1 and GSTR-3B, and with e-invoice and e-way bill data. Unexplained differences can point to unrecorded sales, fictitious invoices or timing manipulation.
How do revenue findings affect the deal price?
Revenue that is not sustainable or was recognised early is removed from adjusted EBITDA in the quality of earnings analysis. Since the price is usually a multiple of EBITDA, even a small revenue adjustment can change the valuation significantly, or lead to specific indemnities in the agreement.
Conclusion
Revenue is not just a number; it is a judgement. Strong top-line growth means little if it rests on early booking, unprovided rebates or one-off income. Due diligence looks past the reported figure to the policy and the evidence behind it, so the price reflects revenue that is real, correctly timed and likely to repeat. Don't just track revenue growth: understand the policy that drives it.
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H K Davra & Co. carries out financial due diligence, quality of earnings and working capital reviews for buyers, investors and lenders.
Talk to usThis article is for general information only and does not constitute professional advice or solicitation. The worked example is illustrative. Standards are summarised as of October 2026. Please refer to the relevant standards and seek advice on your specific facts.