Anthony Robbins- “Every problem is a gift—without problems we would not grow.” Problems come with solutions and every problem is a new experience in the business. How many of you agree with these? Sounding weird? Let’s make it simple!
An organized invoicing system is a must-have for a small business setup. Invoices are sent to the clients as a payment request for the task already completed. Not necessarily, all your projects would turn out 100% perfect, there may be some flaws for which the product may get canceled. And hence, you have to cancel an invoice. Or, in case you may have to add some credits to the account as well. This is when credit notes come into the picture.
Wondering what this is all about? Keep reading this article to learn various facts related to credit notes.
So let’s start with- credit note meaning!
What is a credit note?
A credit note is an official document also known as a credit memorandum or credit memo that is issued by the supplier. This is almost the same as PO or an invoice and is sent to notify customers about the credit that is applied to their account for any particular reason. Moreover, this is a legally binding document.
Do you know?
Audit trails are legally mandatory and deleting invoices is considered unlawful in countries like the US, the UK, Australia, New Zealand and others.
So, practically a credit note helps you out from the legal complication of deleting invoices by just deleting or adding the amount in your financial record without discarding the entire invoice. It can be issued whenever you need to change or re-issue an invoice in any situation.
The basic know-how also includes when and how to issue a credit note. Let’s dig in!
When and how to issue a credit note?
We know credit notes are issued by the supplier, but the question arises when and how?
Let’s discuss it one by one!
There be multiple reasons behind issuing a credit note, some of them are:
- Credit notes can be issued when wrong or damaged products have been delivered to the buyer.
- When the price charged by the seller is more than the actual price, then a credit note is issued to inform the buyer about the changes.
- If a discount has to be applied which was not added at the time of invoice generation, then a credit note is issued to add the new discounted price.
- A credit note can also be issued by a seller when they wish to cancel a payment pending from the buyer.
Now as the reasons are known, let’s discuss how to prepare and issue a credit note with the help of an example.
To understand how to issue a credit note, let’s consider a situation.
The buyer cancels the purchase and hence the invoice has to be cancelled. For this situation a credit note has to be issued.
Now there are two scenarios, either a credit note issued for full amount or 50% amount. Suppose the full amount was $200, then for the first case, credit will be issued for $200.
For the next case, if the amount is being adjusted for a damaged product and returns 50%, then a credit note will also be issued for half-the-amount.
Besides correcting invoice mistakes, credit notes are also issued for various other reasons. Some businesses issue credit notes as part of their LTA(Long Term Agreements). These are also issued to indicate price change of products that may reflect after the invoice has been issued.
This entire process can be done manually and can be sent to the client via email. But this may seem tedious. To make the process faster you can take the help of any software platform that offers credit note templates.
To be more specific about the functioning of the credit notes let’s understand what it includes and when this is used.
What information should a credit note include?
While creating a credit note you must ensure that you include all the key details. Check out the important points!
- Firstly, give the heading “Credit Note” in bold so that clients understand the purpose of this document.
- Credit notes must be issued within one month of the agreement. It should mention the amount that is being reduced from the invoice.
- Credit notes must have a unique number for identification for future reference.
- f it is generated from the client’s end, then it should have the business’s name, address, and VAT number along with the issued date.
- Customer name and address should be mentioned if issued from the vendor’s end.
- Do mention the details as to why the credit note has been generated.
- Mention the total amount as well as the deducted amount. Mention the VAT rate as well.
Take a look at the sections below to know more about this business accounting document!
Tips for implementing credit notes
Are you a freelancer or a small business owner? Do you still follow the old method of using spreadsheets for invoicing? Well, it’s time you switch to an updated version. Simply deleting lines to mark that the specific transaction or a particular product is canceled may create tax issues. If you are VAT registered then you may end up paying the tax on full sale if you don’t follow the regulations canceling an invoice.
Nowadays you get various platforms that offer templates for creating invoices instantly. In those templates, you can’t edit once the invoice is issued. In such cases, you will have to generate credit notes to show the changes. This helps in managing your finances legally. For clients who do not settle their payments on time you can create a credit note, instead, label them as “Bad debt” to show your business expenses.
How do credit notes help in bookkeeping?
Credit notes help in managing your financial records by tracking the completion of business transactions. Let’s understand how credit notes help in bookkeeping!
- For a traditional accounting system, a company can include the credit notes under the sales for each customer. This would help in future reference to track the history of the particular transaction.
- For double-entry bookkeeping, companies should include credit notes under revenue as debit and record it as credit under account receivable.
For accounting software, this process is much easier, where bookkeeping is already included in it. In this accounting software, the credit and the debit amount get automatically linked with the invoice.
If you’re new to the procurement arena, then you confuse credit notes with other accounting documents. Let’s discuss how it differs from others!
Invoice Vs Credit Notes
- Being a business owner you mustn’t get confused between credit notes and invoices. An invoice is a typical financial document that requests payment from the customer. It includes the itemized list of services or products and also provides a detailed description and pricing of each item. It also highlights the total amount the client owes to the supplier.
- On the other hand, a credit note comes in conjunction with the invoice that marks the change in the previous invoice. When a customer returns a particular product to the vendor for a certain issue, a credit note is attached with the invoice by the vendor to subtract the amount of the returned material.
- The invoice tracks the business transaction. Credit note tracks the discrepancy in the product supplied.
- An invoice needs to get revised in cases like duplicate products, wrong items, or customer dissatisfaction with the service. A credit note mentions the deduction of the amount for the deleted item and states the fresh amount. This gives clarity to the client as to what amount they owe to the vendor.
Credit notes vs. debit notes
Besides knowing about credit notes, there is another important document that is worth knowing and that is debit notes. This is also known as a debit memo.
The difference between credit notes and debit notes lies at the point of origin. Credit notes are issued by suppliers and debit notes by the customers.
In case damaged or incorrect products are received, then a customer can issue debit notes claiming a refund of money paid. Also issued in case the customer wants to cancel a purchase.
It is a replacement for a refund, but not exactly a refund. It allows the buyers to purchase the products at a suitable date without paying for them. Issuing a refund involves giving back the cash. But issuing a credit note does not move any cash.
No, a buyer can issue a debit note but not a credit note.
An invoice is an accounting tool that binds both the customer and the vendor on legal grounds. Same way credit notes also represent the business transaction legally that saves extra tax deduction. With the mentioned facts and details about credit notes, you will be able to create a proper credit memo. Billbooks is one such platform that offers a seamless experience for small business owners or entrepreneurs to manage their invoicing process.