Credit notes play an important role in the invoicing process, although they’re not always frequently used, and so can be a little confusing to understand. In this article, we’ll demystify credit notes so you know exactly when and how to use them. We’ll walk you through the detailed information that should be included whenever you issue one, complete with helpful examples and credit note templates. We’ll also explain the key differences between a credit note and a debit note.
Once you’ve learned how to how to integrate this important tool as part of your invoicing workflow, you’ll be confident about using credit notes next time the need arises.
What is a credit note?
Everyone makes mistakes once in a while, and the invoicing process is no exception. This is where credit notes come in.
Credit notes are legal documents, just like invoices, that give you the important ability to cancel out an already issued invoice, either in full or in part.
Issuing a credit note essentially allows you to delete the amount of the invoice from your financial records, without actually deleting the invoice itself. This is significant, because deleting invoices may be unlawful in countries where businesses are legally required to maintain reliable audit trails, such as the UK, the US, Australia and New Zealand.
When to issue a credit note?
Credit notes are typically used when there has been an error in an already-issued invoice, such as an incorrect amount, or when a customer wishes to change their original order. In short, credit notes can be used in any circumstances that would require the invoice to be changed and re-issued.
A credit note is usually linked to an existing invoice, but can also be issued separately, to be used against another invoice in the future. Again, always remember that the completed invoice should never be deleted. This is where the credit note becomes an essential tool in your invoicing workflow.
How do you issue a credit note?
So now you know the typical circumstances when you can issue a credit note, but what does the actual process for issuing one look like?
If you’re using invoicing software (such as Xero), many of these packages can easily issue credit notes against any invoice with the minimum of hassle.
A credit note shows the negative balance of an invoice. For example, let’s say you originally invoiced your customer for a sum of £100. You now wish to cancel the whole invoice, so you’ll need to issue a corresponding credit note for the negative value of -£100.
Or, let’s say you accidentally overcharged the customer by 50%. In this case you could issue a partial credit note for the negative sum of -£50, which effectively corrects the outstanding balance.
What’s more, issuing a credit note should also keep your invoice number sequence intact. For example, if the original incorrect invoice was step one, the credit note will be step two, and the next invoice you issue will be step three. In this way, your records stay clear and organised.
What information should you include on a credit note?
The general format of a credit note is very similar to that of an invoice or quotation. But unlike invoices in particular, the format and structure is less strict.
A credit note should include all necessary information for admin and recording purposes for both you and your customer. Here’s a list of the essentials:
Date of credit note issue
Credit note number
Customer reference number
Reason for issuing the credit note
Also, you should clearly state at the top of the document that it is a credit note, not an invoice, to avoid any misunderstanding on the customer side.
If the original invoice included VAT, then you’ll need to issue a matching VAT credit note, which reflects the details of the invoice, including the amount before VAT.
Here are some credit note examples in the form of templates showing how your credit notes might look.
Credit notes vs. debit notes: what’s the difference?
By now you’re pretty clear on what credit notes are and how they work. But there’s another important document that’s worth knowing about, which may also be involved in the invoicing process from time to time: the debit note.
Also known as a debit memo in some cases, debit notes are issued from the customer to your business to request you to return funds already paid.
Reasons for issuing a debit note can include the customer receiving damaged or incorrect products, or wishing to cancel a purchase in any other circumstances. A debit note acts as a formal request from the buyer to the seller to issue a credit note.
Remove the hassle with GoCardless
While invoicing a customer the wrong amount will happen from time to time, creating sand sending credit notes with as little hassle as possible will help save your finance team time when mistakes do happen.
Using a payment provider like Gocardless, in tandem with automated invoicing software, will help improve the efficiency of your invoicing workflow significantly.
Credit notes are just one part of the invoicing process. To find out everything you need to know about invoicing, take a look at our complete guide.