One of the crucial techniques when carrying out invoicing procedures is to use credit notes. A lot of persons and businesses are yet to harness this important tool when performing invoicing workflow because of inadequate knowledge of credit note.
The aim of this article is to educate our readers about credit notes, showing when and how to use them. In this discussion, we will reveal robust and helpful information needed to give credit notes. In addition, we will provide examples and credit note samples and also differentiate credit from debit notes.
What is a credit note?
Credit notes are commercial and legal documents which empowers someone (a seller) to nullify completely or partially an invoice given to a buyer. This is usually done by the seller because of mistakes, damaged goods or when a transaction is canceled. The importance of credit notes in business transactions cannot be over emphasized, as mistakes are bound to occur more often than not.
An example of where it is used is when a seller discovers that they damaged the supplied goods. He then issues a credit note to the buyer, reducing the amount to be paid for such goods by the buyer. It also provides a negative balance of an invoice.
For instance, assuming a customer initially paid the sum of ksh. 600 to the seller and the seller wishes to end such invoice, he or she will issue a credit note to the buyer for the negative value of – ksh. 600. Also, from the example above, if the seller overcharged the buyer in error by 10%, he will issue a credit note of -ksh. 60 (I.e. 10% of $500) to the buyer which corrects the mistake made in the amount issued originally to the buyer. Credit note is a way of compensating the customer for the defective goods supplied. Credit note provides the seller the room to delete his financial records without erasing the invoice
Common Reasons for which Credit Note is issued
These are some circumstances under which they can issue it are:
- When the buyer discovers he has been charged by the seller below the actual price of product.
- If the seller discovers, he has overcharged in the transaction’s cause.
- The seller issues it when there is a return after sales.
- When the occasion of discount or benefit is to be given by the seller
The examples done below regarding credit note to show that the procedure for issuing it is not complicated as it might seem. Let us explore more with examples
- Assuming company Z made ksh. 700 purchase of products from Company X and later discovered that there was a mistake on the invoice issued, which resulted in an incomplete transaction. How can this be solved?
This kind of situation can be handled as follows: When the error is discovered and company Z has contacted Company X regarding the error, the seller (Company X) issues a credit note on the invoice sent to company Z (the buyer) stating that the issued invoice has been canceled while they also record the status of Ksh. 700 paid as positive in their account payable record. Company Z can then go for a refund or use the amount for future purchases from the same company.
- Assuming company C bought products of value ksh. 40,000 from company K. Later it was discovered that ksh. 30,000 worth of products out of the entire stock were bad. Then they sent a notification to company K regarding those products at the time of delivery. How can such a situation be handled?
This case is best handled by the seller issuing a credit note of Ksh. 30,000 in the name and details of the affected buyer.
When to issue a credit note?
They issue it based on the situations, type of industry or business you are operating on. Some general ones are:
- Note that it is issued whenever there is a mistake in an invoice issued for example when there is an error in the amount on the invoice or damages in the products purchased. It is also employed when there is a need for re-issuance or change of invoice.
- They 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, it can be used in any circumstances that would require the invoice to be changed and re-issued.
- It is also issued when an incorrect item is sent to the customer or buyer.
- Also, it is issued when the price of goods and services is wrongly charged by the seller. The seller sends it to the buyer reversing the extra charge.
- It is also issued for any discount that has not been applied on goods and services at the time the invoice of such is prepared.
- Finally, they are issued by the seller when he wants to terminate pending payment from the buyer.
How do you issue a credit note?
After knowing when to issue it, it is important to know how to issue it to a customer. The process of issuing a credit note is not complex or ambiguous. Let us see how the process looks like.
There are tools and invoicing softwares that makes the process very easy. Example of such software is Xero. This software enables easy issuance of credit notes against any invoice issued originally.
It is crucial that credit notes are kept together with the invoice number in order to keep track of the process. If the affected invoice is number 1, its credit note should be number 2, while the next invoice will be number 3. A credit note should be sent to the affected customers while a copy is kept by the seller. Doing this makes the financial record to be properly kept, and the process organized.
Why you should issue a credit note to your customers
Issuing credit notes to your customers helps your accounting records to be reliable. Once an invoice is issued, it cannot be deleted, but it provides the avenue to do such from your financial records without going against the law.
These cases cited below makes the issuance of credit notes indispensable. Most times the customer returns goods or rejects services for many reasons when:
- There was an error in payment on the original invoice issued
- There was a mistake in price such as overcharging of prices of goods and services on the original invoice.
- The goods were damaged during transit to the buyer.
- There is a need to cancel part, or all of an invoice issued.
- There is no refund policy for returned items, credit notes are issued to the customer as a goodwill act and as such, they can be used in future transactions against another invoice for the same seller.
What information should you include on a credit note?
The format of a credit note looks like that of an invoice, but its structure is less rigid and strict than a quotation or invoice. It is very crucial to state boldly at the top of the document that it is not an invoice but a credit note. This helps to prevent confusion of assuming that it is an invoice. They should include all the information for administrative and account recording used in the credit notes. Some of them are:
- Issuance date
- The number of the credit note linked to the invoice.
- The reference number of the customer
- The terms of payment
- Seller’s contact details such as name, phone number, address, email, etc
- Customer’s contact details such as name, phone number, address, email, etc
- Details from the original invoice such as invoice no, date, etc.
- The purpose of issuing it
- Value Added Tax (VAT) details if the matching invoice has VAT
- Products and their quantities
- Prices of products involved as agreed by both parties
- A new payment terms
All this will enable the customer to comprehend the purpose of the issued credit notes.
Types of credit Notes
There are two main types of credit notes and they are:
- Credit notes for outgoing payments
- Credit notes for incoming payment
Differences between a Credit and a Debit note
Credit and debit notes are not actually the same. Here are some differences between both of them.
- Credit notes are commercial documents containing the record of money that a seller owes a customer, while Debit note is a document where the money a client owes a seller is recorded.
- Credit notes give a negative balance of an invoice, while debit notes provide a positive balance of an invoice.
- The seller of goods and services issues A credit note, while the buyer of such goods and services requesting for a credit note issues a debit note.
Credit note is very essential for account record keeping of business transactions. Errors usually occur in the cause of documenting business transactions. Hence the need for credit notes to take care of such errors and prevent unnecessary hassle for the finance officers when such errors occur.
While preparing it, great care has to be taken to ensure that all the necessary information is captured in the credit note. It should contain VAT details for the matching invoice issued together with the amount before VAT. It should be clearly stated that the document is a credit note and not an invoice, as this will confuse the customer when not specified. Armed with this information, we strongly believe that you will be well informed to use credit notes whenever you need to do so.