What is a credit note? A guide for the self-employed
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If you are used to sending invoices, you may have heard of a credit note, issued or received one. However, credit notes can be slightly confusing when it comes to knowing when and how to create one.
This guide will help you understand how this procedure works, answering the following questions:
- What is a credit note?
- When do I send out a credit note?
- How do I create a credit note?
- What information do I need to include?
- What is a debit note?
- How do I include credit notes in my bookkeeping?
What is a credit note?
Mistakes happen and the invoicing process is no exception. Businesses need a way to correct these mistakes while keeping their invoices organised. That’s where credit notes come in.
Like invoices, credit notes are legal documents that enable you to cancel an already issued invoice, either in full or for particular items.
Sending out a credit note allows businesses to delete the incorrect amount from their financial records without deleting the invoice itself.
When do I send out a credit note?
You typically use credit notes when there’s been an error in an invoice you’ve already sent to a customer or client, such as an incorrect amount or item. You can also send credit notes if a customer or client wants to change their original order. In short, you can use credit notes in any situation where you need to change and re-issue an invoice.
Typically, a credit note links to an existing invoice. However, you can also issue a credit note separately to be used against another invoice in the future. For example, you may attach your credit note to your customer’s next invoice, deducting the refunded value from the total amount.
Issuing a credit note should keep your invoice number series intact to help your records stay clear and organised. Remember that you should never delete an invoice, even if it’s incorrect.
Why is this?
A deleted invoice creates a gap in your invoice trail. Sometimes HMRC may track your records to make sure you pay the correct amount of tax. If HMRC notices a missing invoice, you could get fined or even prosecuted. This is why the credit note is an essential tool in maintaining your invoicing workflow.
How do I create a credit note?
Creating a credit note doesn’t have to be complicated. Simply copy the information from the invoice and paste it into the credit note. There are plenty of downloadable templates you can use, or you can build one from scratch.
Once you’ve copied the information into the credit note, edit the contents as necessary, for example, by removing certain items or correcting an incorrect amount. When you’re done, assign the relevant invoice series number to the credit note to avoid leaving any gaps in the invoice trail.
For example:
Let’s say you invoice your customer for a sum of £100, which you now wish to cancel in full. You’ll need to issue a credit note for the negative value of -£100.
Looking at another example, say you accidentally overcharged your customer by 50%. In this case, you’d issue a credit note for the negative value of -£50, effectively correcting the error.
What information do I need to include?
Credit notes have a similar format to invoices or quotations. However, credit notes have a less strict structure, especially compared to invoices.
You need to include the information needed for admin and recording purposes for you and your customer or client, which are as follows:
- Date of credit note issue
- Credit note number
- Customer reference number
- Payment terms
- Contact details
- Reason for issuing the credit note
Remember to clearly state at the top of the document that it’s a credit note, not an invoice, so as to avoid misunderstandings or confusion. Additionally, if the original invoice included VAT, you need to issue a matching VAT credit note that reflects the invoice details, including the amount before VAT.
What is a debit note?
A debit note, or debit memo in some cases, is a document your customer issues to your business asking for a refund. Reasons for issuing debit notes could be that the customer received a damaged product or the wrong item. Or perhaps they changed their mind about the product. A debit note is essentially a customer’s formal request for you to issue a credit note.
How do I include credit notes in my bookkeeping?
In terms of keeping records for your business, managing credit notes is fairly straightforward.
In traditional accounting, you’d enter credit notes as a credit* in the sales log for that particular customer, effectively crediting their account for the amount.
If you’re using a double-entry bookkeeping system, where every financial transaction has equal and opposite effects in at least two different accounts, the process is different. In that case, you record the credit note as a debit* under ‘Revenue’ and credit under ‘Accounts Receivable’ (money owed to you).
Make sure you record and update every credit note as needed, for example to adjust stock if a product is returned.
*Debit is money that’s been paid, and credit is money that’s due to be paid.
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