A credit note is a type of legal document, similar to an invoice that is sent from a business (seller) to its customer (buyer). It details a credit that is owed against a previously issued invoice. This credit note can then either cancel out that invoice, or reduce its amount.
Credit notes are an essential element to invoicing that every business should know about, and will likely use. Although they aren’t issued as regularly as quotations, invoices, purchase orders or receipts, they are a standard document.
They enable an invoice amount to be deleted, but not the invoice itself. Deleting invoices is illegal in many countries as businesses must keep clear, traceable financial records.
In this article, we answer the following questions:
- When should your agency use a credit note?
- What’s included on a credit note?
- What happens if you don’t use a credit note?
- How to reduce the use of them?
- How to raise a credit note?
- How are they different to debit notes?
When Should Your Agency Use a Credit Note?
If you have a steady stream of clients and plenty of projects on the go, cash flow problems can be prevented, or at least minimised.
All you need is a toolkit of tips and a positive attitude to achieving positive cash flow.
Whether you hand this job over to an accountant or not, making sensible projections about future income and expenditure is essential for business planning. Aim to forecast for between three to six months into the future. You’ll never be 100% accurate but it will give you a broad overview of where you stand.
For example, if you know that clients go quiet in December, you can plug this into your cash flow analysis and anticipate possible issues. This allows you to take steps to cover the shortfall and delay any major expenditure plans.
When your forecast points towards a healthy period of uninterrupted cash flow, you can plan to recruit your next member of staff or make that long-awaited office move.
Streamline Credit Control
When you implement regular and structured credit control in your digital agency, your financial admin instantly becomes slicker.
Dedicated software packages can automate the process, issuing invoices to clients and sending reminders when they’re due. Getting yourself organised can free up precious time to focus on clients rather than spreadsheets.
If you’re regularly dealing with late payees, negative cash flow consequences are inevitable. Nobody wants to be making awkward calls chasing up late payments, so do all you can to minimise the possibility:
- Consider invoicing once work is complete instead of routinely at the end of the month. That way you won’t be relying on a lump sum arriving at once and, if you have multiple late payees, the impact won’t be as intense.
- Make it easy for customers to pay you. Setting up a Direct Debit scheme is ideal for retainer clients who are charged a monthly fee. You’ll also reap the benefits of regular, reliable payments as you receive the expected amount on the expected date.
- Make sure invoices are accurate and payment terms are clear, especially late payment fees. If your client quibbles a detail, you’ll be dealing with delay.
- Assess your suppliers’ payment terms and change yours to correlate. If you’re regularly paying bills sooner than your invoices are being paid, a cash flow gap is more likely.
Review Your Pricing
There are a few situations in which you’ll need to issue a credit note. These include:
– Amount Error
Mistakes happen, and occasionally an invoice might be issued with an error. For example, an invoice for £105 could be detailed as £150 or an extra zero might be added due to an input error.
In this instance a credit note would be raised and issued to the customer for the incorrect amount, so that the balance shows the correct amount. In our example above, a credit note for £45 would be issued against the inaccurate £150 invoice so that the balance shows £105.
Your accounts and that of your customer will now correctly show the debt of £105 after posting both the original invoice for £150 and the credit note for £45.
When you appreciate its importance in the success of your agency and spot the symptoms of a possible cash flow gap, adopting a few simple methods of mastering positive cash flow will pay dividends.
Freed from the worry of dwindling cash supplies, you can plan for the future with confidence. A future that will see your agency shine.
– Customer makes a change to their order
If you have raised and issued an invoice and afterwards, the customer makes a change to their order then you’ll need to reissue the invoice. As you should never delete invoices, you’ll use a credit note to cancel out the original invoice so that you can issue a new invoice with the updated amount.
So, an original invoice with a value of £400 will have a credit note of £400. Then you can reissue a second invoice with the updated amount, e.g. £600, and the amount the customer owes will show £600.
– Order refunded due to a returned product or service
Occasionally customers aren’t satisfied with a product or service, perhaps it’s faulty or they have changed their mind on a service, and have returned it for a refund.
In this instance, a credit note will be used to show the refunded amount.
– Order changed by the business
A credit note would also be issued if the business changes the order. For example, a discount is applied in retrospect.
Agencies that charge by the hour might invoice a client for a certain sum of hours for a project and, after completion, find that they have only spent half the number of estimated hours. The agency could then issue a credit note for those hours that weren’t used so the client only pays for the utilised time
What’s Included on a Credit Note?
As a credit note is a legally recognised document it needs to have certain information included:
Your business information including name and contact details
VAT registration details, if your business is registered
Customer’s information including name and contact details
Credit note number, unique number that follows on from the last credit note
Account number, if you have a reference for your customer
Reference number, if you have a purchase order number or delivery number
Date of credit note issue
Invoice number of the original invoice
Description of why the credit note is being issued and the goods/services it’s for
Total amount to be credited
Information will change depending on your business and whether you use accounting software that automatically creates credit notes with standardised information.
However, it’s important to ensure the document has ‘Credit Note’ clearly detailed so there is no mistaking it for an invoice. VAT credit notes need to clearly show the VAT information and price before VAT.
What Happens If You Don’t Use a Credit Note?
Credit notes are a standardised way of managing your accounts and ensuring there is a clear audit trail for income and outgoings for both you and your customers. It’s best practice to keep everything ‘in writing’ and in documents that can be saved electronically in case they are required by authorities.
Verbally agreeing refunds or credits with customers, and not facilitating them correctly in your accounting can lead to problems down the line. It might also damage your relationship with customers if you don’t follow the standard invoicing procedures.
In the UK, HM Revenue and Customs (HMRC) requires businesses to keep their records for at least five years. Verbal agreements can be forgotten in that time, but orderly accounts can be quickly and easily retrieved from online archives.
What Happens If You Don’t Use a Credit Note?
Credit notes might seem fussy to organise, however mistakes happen and orders change.
There are a few ways to reduce their use, for example if you invoice your customers on a recurring basis, then setting up Direct Debits to automatically collect payments will help to reduce admin and human error.
Also, analysing why products are being returned or services cancelled will help you update product quality if there are recurrent faults or tweak service offerings so they satisfy customers.
For digital agencies, to avoid changes in orders or cancellations after the invoice has been issued, it’s important to have a clear process before the invoice is raised.
This can include:
- line item budgeting for new projects
- sharing clear and detailed quotes with a client
- following a strict approval process which involves getting signatures and/or written approval
- sharing contracts with specific terms and conditions that detail what happens if a job is cancelled e.g. a percentage charge of the total or an agreement to pay for hours worked etc
- not starting work on a project until a purchase order is received
How to Raise A Credit Note?
Online accounting software, such as Xero, will have the raising and issuing of credit notes built in to their system. This means that the credit note template will pull in all relevant data, be linked to the original invoice and automatically update the balances. It will also allocate a unique credit note number and save the credit note for future audits.
If you don’t use software and manually run your bookkeeping then there are a number of templates for credit notes available online. You need to keep in mind the stage at which your invoice is at as this will require different handling. For example, an invoice that has been paid by the customer and now requires a refund should be processed differently to an invoice that hasn’t yet been paid.
How Are Credit Notes Different to Debit Notes?
A debit note is a document that is sent by the customer (buyer) to your business (seller) to formally request you issue a credit note.
This could be due to any of the reasons noted above, such as an error on the invoice. Your client might’ve noticed the mistake before you did and so issues a debit note to you. Issuing debit notes is another way to keep financial records in order as the customer can then log on their accounts that they are owed a credit or refund. They can then chase the payment if necessary and mark it as complete when done.
Credit Notes for your Agency
Credit notes are a standard invoicing process that your digital agency should use. Although they might not be issued as often as other documents such as invoices, they have a specific purpose. Occasions will arise when an invoice needs to be cancelled or amended, and they are the accepted method to do this to keep your financial records in order.
If your agency is issuing a high number of credit notes, analyse why this is occurring. Perhaps review your project approval process so clients are fully aware of the costs of a project before it’s progressed, or include terms in your contracts that charge clients for cancelling projects. This deterrent will hopefully ensure clients are fully committed to progressing a job with your agency and don’t cancel or change their minds after the invoice has been sent.