In running a business, there may be activities and transactions that feature terminologies that are quite confusing. However, the confusion shouldn’t stop or hinder daily business operations. Having a clear understanding of day-to-day business terms and their corresponding usage is essential for fundamental growth. That’s why a deeper understanding of the major differences between a credit memo and an invoice is also crucial.
Both of these terms are important as they are your common business terminologies that you come across every day. Getting familiar with both credit memo and invoice will help you have a clearer vision about each term and their practical usage in the world of business. Continue reading to learn more about the credit memo and invoice.
What is an Invoice?
An invoice is a list of items for which a customer or company has to make payments to its suppliers, service providers, or vendors. The accounts payable department receives invoices from the suppliers or vendors and assesses it before processing for payment. The company issues a ‘Purchase Order‘ (or PO) to the vendor, requesting the items to be supplied to them. The Accounts Payable department will then match the items listed on the PO with the invoice to verify that all the items that they receive are on the list. An invoice also serves as proof that a company or customer has received the items they have ordered and that they are to pay for the corresponding prices.
What is a Credit Memo?
So, what is a credit memo? At this point, you are already aware of what an invoice is and its role in your business. If an assessment has been made and everything is perfect, the items on the purchase order will match exactly with that of the invoice. Once products are received, the invoice is then processed for payment. Keep in mind that a credit memo should not be mistaken with a debit memo. Debit memos are different types of documents which will be tackled in a different topic.
However, if there appears to be any disparity or inconsistency, such as the items received are not in good condition or those wrong items are supplied, the items will be returned to the supplier. Once this happens, a credit memo – otherwise known as a credit note – is issued.
Once the buyer returns items, the vendor will need to issue a credit memo for the returned items. Credit memos are also issued once the client has paid advance payments to the vendor. This document ensures that the vendor has been informed about the discrepancy in the supplying and agrees to the credit memo requested by the customer for the items not supplied exactly through the purchase order.
With all that said, what’s the role credit memos and invoices? The Accounts Payable Department of a company will use both the invoice and credit note for the payment processing. It will then deduct the amount of the credit memo from the invoice and clear the payment for the vendor.
How To and When Use a Credit Memo
As you may have learned by now, a credit memo is a useful tool for small business owners, It’s also particularly useful to both the seller and the buyer. According to Paychex, these are the several instances where a credit invoice might prove useful.
Of course, we need to mention first the most fundamental use of a credit memo, which is to acknowledge returned goods. If a customer returns goods that were billed previously, the vendor can issue a credit memo to adjust the amount due from the customer. Credit memos are essential to both the buyer and seller. It’s essential not only for tracking payables and receivables but also for recordkeeping and inventory tracking purposes. It’s an excellent practice since it clearly states the reason for the credit memo for the return. For instance, both the customer and vendor will know if the product was spoiled or defective, or if the customer was simply unsatisfied with the product.
Pricing Disputes and Inconsistencies
There are instances when a buyer contests the price that they are billed. This situation can be resolved by means of an informal agreement between the parties, minding mediation, or a legal proceeding. If the result is a reduction in the price that’s invoiced initially, a credit invoice will then be issued. That makes it extremely useful for small business owners who are looking to settle any pricing disputes.
In other cases, the seller may wish to give one particular buyer a break on the costs that were originally billed. This strategy is to establish goodwill and customer loyalty.
Errors with the Original Invoice
In other instances, the issuer makes an error in creating the invoice. In that case, a credit memo is the easiest way to resolve this situation. By issuing a credit note, business owners will be able to determine the exact invoice amount. They won’t have to use any accounting software since the credit memo already outlines the adjusted rate of the total payable amount.
A credit note will be issued if balancing isn’t accurate. Sometimes, a credit invoice can be used as an internal memo, which is also used to make adjustments to the accounts receivable balances. This issue might occur when a debt becomes uncollectable, and the seller removes the outstanding balance. This is also possible if a customer sends a payment that’s a little short and the seller will not collect it.
What’s Included in a Credit Memo?
In its simplest form, a credit memo is a letter that outlines all of the reduction in sales. However, for it to be effective, it needs to contain several parts and elements. That way, the credit memo will be filled with the necessary information that will serve as proof of the changes in the pricing of the goods. Here are some of the things that should be included in a credit memo:
- Start with the heading. Write down, ‘Credit Note,’ ‘Credit Invoice,’ or the standard ‘Credit Memo.’
- Mention the value that will be reduced from the invoice versus credit note invoice.
- The credit invoice must be issued within a period of one month of the agreement.
- Your credit note for the invoice should also have an identification number, as well as an issuing date. Don’t forget to mention the company name and address, as well as the VAT number.
- Mention the name and address of the supplier or vendor that you’re crediting.
- State the reason for issuing a credit note.
- Add the total net amount for the purpose of the credit (excluding VAT).
- The rate of applicable VAT and the amount to be credited under VAT.
- The gross amount of credit, including any applicable VAT.
These nine items are the complete process of generating a credit note for your customers. Always keep them in mind so that the next time you are creating a credit memo, you’ll know what to include. Credit notes will mention multiple items, so make sure you include everything mentioned above.
So as you can see, both invoices and credit memos are completely different from each other. However, they are still related to each other. Invoice is the list of all the items being purchased, while the credit memo is a document that is issued once an invoice goes wrong. As someone who is running a business, you must be aware of these terminologies. That way, you will be aware and familiar once you come across each one during your daily transactions.