Unearned revenue, or deferred revenue, typically represents a company's current liability and affects its working capital by decreasing it. Unearned revenue is recorded when a firm receives a cash advance from its customer in exchange for products and services that are to be provided in the future. Because a company cannot recognize revenue on this cash advance and it owes money to a customer, it must record a current liability for any portion of the cash advance for which it expects to provide services within a year. Since current liabilities are part of the working capital, a current balance of unearned revenue reduces a company's working capital.
Unearned revenue typically arises when a company receives compensation and it still has to provide products for which the payment was made. Consider a media company that asks its customers to pay $120 in advance for annual subscriptions to its monthly magazine. When a customer sends a $100 payment, the media company records a $100 debit to its cash balance and a $100 credit to its unearned revenue account. When the company ships magazines to a customer once a month, it can decrease its unearned revenue by $10 by recording a debit to the unearned revenue account and a $10 credit to its revenue account.
Working capital is the difference between a company's current assets and its current liabilities, which it records on its balance sheet. If a company has a balance of earned revenue for services it intends to provide within a year, this balance is considered a current liability and would decrease the working capital.