You’ve just received a return from one of your loyal customers, and they’re asking for a credit memo.
Your company has never issued one of those before.
Rare is the time that you receive a return, and when you have, it's always before the invoice has been paid, so you’ve just adjusted the invoice.
The good news is that issuing a credit memo is actually super easy.
In this article, we’re going to explain exactly what credit memos are, what information they include, when and why they’re issued, and best practices for using them in your own organization.
What is a credit memo?
A credit memo is an official document issued by the seller to the buyer, acknowledging that a given amount has been credited to that buyer’s account.
It's short for credit memorandum, but nobody really uses the full name. You might also hear it referred to as a credit note (memorandum literally just means note).
Credit memos are issued when a buyer returns goods or receives a discount (perhaps for goods that don’t meet quality standards). They may also be issued to rectify an issue or error with an invoice that has already been paid.
A credit memo reduces the amount the buyer owes to the seller. Rather than refunding a payment already received, you issue the buyer credit toward future purchases.
The credit memo serves as an official record to acknowledge this credit.
What information is found on a credit memo?
Credit memos are pretty standard documents and always contain the following information:
- Credit memo number: A unique identifier for tracking and locating the credit note at a future date
- Date: The date on which the credit memo was issued
- Original invoice number: The number of the invoice that the credit memo is in reference to
- Seller details: The name, address, and other key contact details for the vendor issuing the credit memo
- Buyer details: The name, address, and other key contact details for the buyer receiving the credit memo
- Description: A detailed description of the goods or services that are being credited
- Reason for credit: A detailed explanation of why the credit memo is being issued, such as error correction or return goods
- Amount: The total amount being credited to the buyer’s account, including any applicable itemized breakdown (if multiple products have been returned, for example)
- Payment terms: Any applicable terms related to the application of the credit toward future purchases or the buyer’s right to request a refund
- Authorized signatures: Signatures or approvals from the appropriate employees on the seller’s side
When are credit memos issued?
There are a few common scenarios in which credit memos get issued
After the return of goods
The most common reason for a credit memo being issued is because the goods that were purchased were returned.
This might be because the items received were defective, damaged, or otherwise not up to the quality standards set out in the supplier agreement. It could also be because the vendor provided the incorrect product.
In some cases, there is no problem per se. The buyer just decided they no longer need the goods, such as when a mechanic purchases car parts in anticipation of an upcoming job, but the customer cancels.
In place of a refund
Sometimes, a credit note is issued in place of a refund, such as when an order is canceled after a payment has already been made or if the buyer is dissatisfied with the product or service received.
To reflect a price adjustment
Credit memos can be used to reflect post-sale discounts. For instance, if a given product comes on sale just after the purchase was made, the vendor might opt to offer a credit memo to the buyer to reflect the newly discounted price.
Similarly, credit memos can be used to rectify a pricing error on the original invoice, if that invoice has already been paid by the buyer.
When the contract is changed
In some cases, changes to a buyer-seller contract may result in the need to adjust previously billed amounts.
For example, your sales team may have just negotiated a new annual contract with a major customer. As part of that negotiation, they agreed to apply the new pricing terms to the previous three months’ worth of invoices.
In this case, a credit memo will need to be issued to reflect that contractual rebate.
Why are credit memos important for businesses?
Credit memos are helpful for the business issuing the memo as they allow accounts receivable teams to rectify incorrect invoices, fix mistakes, reflect post-invoice negotiations, and avoid processing refunds.
For the business receiving the credit note, it acts as proof of available credit, which they can then use toward future purchases.
Credit memos are an important part of financial record-keeping for both organizations, providing an audit trail that tracks financial transactions between the two companies.
Best practices for using credit memos
Credit memos are pretty straightforward, but it's still a good idea for finance leaders to be aware of these best practices.
1. Develop and distribute clear policies
Draft an SOP (standard operating procedure) for your accounts receivable team that outlines when, where, and how to use credit memos.
It should also include information about authorization, such as approval workflows to follow and who is authorized to issue credit memos under which circumstances.
2. Always attach invoices to credit memos
Make it a habit to always include relevant invoice numbers on each credit memo you issue for easy reconciliation.
3. Use standardized templates
Credit memos don’t differ too much from one to another. For that reason, there’s no need to reinvent the wheel each time you want to issue one.
It's a smarter move to create a standardized template and have your team use the same one each time, saving a tonne of tedious manual work.
4. Provide detailed reasons for issuing credit memos
One of the core sections of the typical credit memo is the reason for issuing it in the first place.
Make it a standard practice to fill this section in with as much detail as possible. Stock standard answers like “return” or “price adjustment” aren’t specific enough.
If an issue arises further down the track, you probably won’t remember why the price was adjusted in that specific case.
So, write detailed notes. You’ll thank yourself later.
5. Keep on top of customer communication
It's standard practice to email credit memos to customers once they’re issued.
But it is also a good idea to maintain communication beyond that, such as confirming once the credit has been applied to a future purchase or chasing up customers with outstanding credit notes.
6. Leverage financial automation
As your organization scales, your accounts receivable team is likely to be issuing dozens of credit notes a month or more, depending on the industry you work in.
Financial automation software can be a powerful way to streamline credit memo management and take a lot of repetitive manual work off your team’s plate.
These modern solutions can automatically issue credit memos when goods are returned, reconcile memos with invoices, and autofill key information like supplier and buyer contact details, integrating with the rest of your finance tech stack.
Credit memo vs debit memo
Credit memos are issued by a buyer to a seller to reduce the amount the seller owes.
This might be to fix and error in the original invoice or to reflect post-sales negotiations. It decreases the seller's accounts receivable and the buyer's accounts payable.
Debit memos are the opposite. They are issued by the buyer to the seller to increase the amount the seller owes.
Rather than sending another invoice, a debit memo is issued to reflect adjustments to the original invoice, which might also be to fix an error or to increase pricing.
A debit memo increases the seller’s accounts receivable and the buyer’s accounts payable.
Keeping on top of credit memos
Credit memos are an important and necessary part of the accounts receivable process.
As your financial operations grow, the number of credit memos you’ll need to create, send, and keep on top of is only going to increase.
Manual credit memo management simply isn’t scalable. You need a modern financial operations platform that can help you easily issue credit memos for specific invoices, with deep reporting capabilities that help you understand how your outstanding credit notes will impact cash flow.
Check out BILL, the automation solution for business finance professionals, today.
