What is a credit memo?

A credit memo is an official document issued by a seller to a buyer used to amend invoices by reducing amounts paid due to errors, returns and/or price adjustments in sales transactions. 

To be more specific, a credit memo is issued when a business needs to adjust, revise or cancel all or part of an invoice that has already been issued and paid.

A credit memo is also known as a credit memorandum or a credit note.

A credit memo is different from an invoice, a refund or a debit memo (the last one increases the amount a customer owes).

Refunds mean giving money back to a customer the payment for services rendered or products received. Invoices let customers know what they owe a seller.

Why are credit memos important for business?

Credit notes allow businesses to delete the amount of the invoice from their financial records without the need to delete the invoice itself.

Since audit trails are legally mandated, deleting invoices is unlawful in the US, the UK, Australia, and New Zealand.

Components of a credit memo

  • The issue date of the credit note.
  • The credit note number (this is often linked to the invoice number to easily search and manage credit notes within your system).
  • Payment and invoice data (bookkeeping details such as payment methods and expectations for repayment — for example, note if the buyer has already paid part of the bill before getting the credit memo).
  • Reason for credit (clearly state the reason for issuing the credit — customer-returned goods, overpayments, invoice correction or adjustments, etc.).
  • Credit amount (how much of a credit the buyer is owed, including any tax refunds).
  • Contact details (company name, phone number, billing/shipping address, VAT number/EIN).
  • Signature (both parties should sign the credit memo to make it valid and legally binding. A signature acknowledges receipt of services or products).

When is a credit memo used?

In short, a credit memo is used whenever the buyer has a qualifying reason not to pay the full amount of an issued invoice.

Let’s briefly elaborate, exploring each common type of credit memo used in business.

Damaged or defective goods delivered

In case a buyer gets a damaged product, wrong supplies or inappropriate goods and the transaction has already been sealed, business owners can offer the buyer a credit for the cost of the damaged product to buy other products. 

Price dispute 

A price dispute credit memo is usually issued when prices are changed after the transaction is done.

For example, a buyer has purchased a product of $1000 from the seller company, then the price of the same product got reduced (for example, because of a sale or weekly special) and the price now is $900.

The deal is already sealed, so the seller company will need to issue a credit memo of $100 as a price dispute.

Customer has overpaid on the original invoice

An overpaid credit memo will be issued when the prices written in the invoice are incorrect (the seller paid more than the cost of a product).

For example, this usually happens when customers accidentally pay the invoice twice due to bank issues or when they didn’t factor in their personal discount.

Customer has made a change to an order

A credit memo can also be issued in cases where a customer has altered the original purchase order after the invoice has been issued. 

Errors to avoid when issuing a credit memo 

Aside from issuing a credit memo, a business should also properly manage these documents in order to mitigat interruptions in the purchase closing process.

These are main issues to avoid.

Mismatch in credit memo and invoice details

Always ensure that the details of a credit memo match the original invoice. Some points to check are:

  • Invoice number;
  • Customer account details;
  • Goods or services listed.

Incorrect amount

Minor mistakes in the invoice amount can significantly impact your accounts.

It is especially common in complex adjustments like partial returns or discounts, so they should always be verified before issuing a credit memo.

Lack of standardization

A standardized format for issuing credit memos reduces confusion, common mistakes and streamlines auditing and sending.

You can use automated sales invoice software like PandaDoc for invoice templates, billing and management, and all other accounting software needs. 

Delays in issuing credit memos

Customers don’t like delays in receiving credit that they are due.

So a best practice is to issue credit memos timely by using document management software to prevent financial reporting disruption and increase customer satisfaction.

Unauthorized credit memo approvals

Avoid any unauthorized adjustments by granting access to only relevant members of your team, ensuring each credit memo is verified and signed

Streamline invoice creation and management processes with PandaDoc

As a business selling goods or services you may often deal with credit memos.

Accounting software can help streamline the process, allowing you to use templates and quickly manage credit memos without mistakes. 

You can always explore PandaDoc’s all-in-one solution.

Our platform allows you to create, send, track, and e-sign sales invoices in minutes using templates or creating one from scratch. 

Schedule a demo or start a free trial today!