This article is not designed to describe accounting practices such as double-entry bookkeeping, debtors accounts etc. It is aimed at someone who wants to gain an initial insight into what Invoices, Credits and Refunds are from the more practical point of running a business - how they help you to convey necessary information to your customers, and, almost as a "by-product", enable you to keep accurate financial records.
As a business owner, even a small business owner, you have to maintain certain accounting records relating to all your financial transactions. This is a legal requirement. One of the key documents that you need to keep a record of is your invoices. Most people are aware of what an invoice is, firstly because they will have received invoices from suppliers, and secondly because there is generally a good understanding of the purpose of an invoice; that is to provide details of products and or services that you have provided to a customer, including a description of those products or services, and the amount that you have charged for each.
For many business owners, the production of an invoice is the first financial document that they will create. Quotes, estimates or orders do not constitute part of your finances; only the invoice that may be generated from them makes up a part of your financial books.
There are many different ways to run a business with regards to how the invoicing may be done, but in general you will either provide goods or services at which time you will recieve the payment for these and produce (raise) an invoice (or in fact it is a receipt which is an invoice showing payments received), or you will raise an invoice at the same time as you supply the goods or services, but will not receive money until later. You may do this for regular customers to whom you have given credit and payment terms.
For the purposes of looking at the role of invoices, credits and refunds, we will work on the basis that we provide products to our customers, at which time we will raise an invoice, and that our customers all have ten working days to pay the invoice.
By raising an invoice we are doing two things:
1. We are advising our customer of the products that we have provided to them, their total cost, and therefore what they owe us.
2. We are keeping a record for ourselves of what our customer owes us; we don´t want to provide products to customers and then forget to get the payment for them!
Let us assume that we have raised an invoice for Joe Bloggs Enterprises, because we have supplied them with 10 red widgets at £10.00 each, and 10 blue widgets at £15.00 each. For the purposes of simplicity we will also assume that we are not VAT registered so there will be no additional VAT to charge for any products that we supply.
The invoice for the above will include the following information:
Invoice To: Joe Bloggs Enterprises
Invoice No: 1009119
Invoice Date: 01/01/2008
| Description |
Unit Cost |
Quantity |
Total Cost |
 |
| Red Widget |
£10.00 |
10 |
£100.00 |
| Blue Widget |
£15.00 |
10 |
£150.00 |
|
|
|
Invoice Total: |
£250.00 |
|
We will actually need to include more information on this. (See our article on [ What information do I need to include on an invoice ] for fuller details on this.) For the purposes of this article we are looking at the financial information our invoices convey.
In short, we are advising Joe Bloggs Enterprises that they owe us £250.00 and that this amount is for 10 Red Widgets and 10 Blue Widgets.
This invoice is unpaid, and therefore there is a balance due of £250.00. If we were running a paper based invoicing system, we would put this invoice into a folder marked "Unpaid Invoices" - and there it will stay until it is fully paid. In this way we can easily find invoices that we are still owed money on.
| Invoice Number |
Invoice Amount |
Amount Received |
Balance Due |
|
| 1009119 |
£250.00 |
£0.00 |
£250.00 |
As we receive payments, we can allocate these against this invoice so that we can see how much is still outstanding:
Let us assume that we receive a payment of £100.00, which Joe Bloggs Enterprises have advised us is for the Red Widgets - there is a query about the Blue Widgets!
| Invoice Number |
Invoice Amount |
Amount Received |
Balance Due |
|
| 1009119 |
£250.00 |
£100.00 |
£150.00 |
We can see that there is now only £150.00 owing on Invoice 1009119. In "normal" circumstances we would hope to receive the next £150.00, at which point our information would look like this:
| Invoice Number |
Invoice Amount |
Amount Received |
Balance Due |
|
| 1009119 |
£250.00 |
£250.00 |
£0.00 |
In this case, if we were running a paper based invoicing system, we would move this invoice into the "Paid Invoices" folder so we know that all monies have been paid on it and we no longer need to chase payment.
However, life is vary rarely "normal", so let´s assume the following:
We have recieved only £100.00 for invoice 1009119 so our financial information looks like this again:
| Invoice Number |
Invoice Amount |
Amount Received |
Balance Due |
|
| 1009119 |
£250.00 |
£100.00 |
£150.00 |
Joe Bloggs Enterprises have now checked their records and realised that they did not want to order 10 Blue Widgets as well. We will assume in this instance that we are happy just to receive the 10 Blue Widgets back. However, as things stand we currently have a balance of £150.00 showing on the invoice, so we can´t move the invoice to the "Paid Invoices" folder.
You may just say "Let´s delete the line on the invoice that refers to the £150.00", but that is not good accounting practice and the Inland Revenue would not be pleased about it! Once you have raised an invoice and sent it to a customer, you should not alter that invoice.
This is where a Credit (or Credit Note) comes in to play. Just as a payment against an invoice reduces the balance due on that invoice, so does a Credit. In essence you can think of a Credit as a payment against an invoice, though it isn´t a payment that has been received from a customer, it is just a paper based movement that reduces the amount of the invoice or in effect deletes that value from the invoice. (Although this article isn´t about double-entry accounting practices, just for the record, the payment actually comes from the Debtors account - but you don´t need to worry about that).
To keep things entirely clear, we could have an additional column of information to show credit information separately, so that we would now have:
| Invoice Number |
Invoice Amount |
Payment Received |
Credits |
Balance Due |
|
| 1009119 |
£250.00 |
£100.00 |
£0.00 |
£100.00 |
| 1009119 |
£250.00 |
£0.00 |
£150.00 |
£0.00 |
For total completeness we should also record the date on which each of these transactions occurred:
| Invoice Number |
Invoice Amount |
Transaction Date |
Payment Received |
Credits |
Balance Due |
|
| 1009119 |
£250.00 |
05/01/2008 |
£100.00 |
£0.00 |
£100.00 |
| 1009119 |
£250.00 |
10/01/2008 |
£0.00 |
£150.00 |
£0.00 |
More usually we would show such information in our books as:
| Date |
Transaction Type |
Credit |
Debit |
Balance |
Ref |
|
|
|
|
|
£0.00 |
Opening Bal |
| 01/01/2008 |
Invoice |
£0.00 |
£250.00 |
£250.00 |
1009119 |
| 05/01/2008 |
Payment |
£100.00 |
£0.00 |
£150.00 |
1009119 |
| 10/01/2008 |
Credit |
£150.00 |
£0.00 |
£0.00 |
1009119 |
Our invoice now has a balance due of £0.00, so we can place it in our "Paid Invoices" file. We would also want to send a printed Credit Note to Joe Bloggs Enterprises for the amount of £150.00 which they will keep with their invoice, so that they know that they do not owe us any more money on the invoice. We would also keep a copy of the Credit Note with our invoice in our Paid Invoices folder for completeness.
So a credit note is a way of reducing our invoice value if a mistake has been made, for whatever reason, rather than deleting the mistake.
So, what is a refund? You are probably already aware of what a refund is. If you have ever returned something to a shop, you will get a refund for it, i.e. they will give you back your money. This is exactly what a refund is, though of course you will only give back money to a customer if they have paid you in the first place. In the above example, Joe Bloggs Enterprises had not paid for the Blue Widgets so we wouldn´t want to give them any money back - the Credit Note was sufficient to reduce the Invoice balance to zero.
Now lets assume that they DID pay the invoice in full, before they discovered their mistake with the Blue Widgets:
| Date |
Transaction Type |
Credit |
Debit |
Balance |
Ref |
|
|
|
|
|
£0.00 |
Opening Bal |
| 01/01/2008 |
Invoice |
£0.00 |
£250.00 |
£250.00 |
1009119 |
| 05/01/2008 |
Payment |
£250.00 |
£0.00 |
£0.00 |
1009119 |
They discover the issue with the Blue Widgets, so return them to us, so we create (or raise) the Credit Note as we did before:
| Date |
Transaction Type |
Credit |
Debit |
Balance |
Ref |
|
|
|
|
|
£0.00 |
Opening Bal |
| 01/01/2008 |
Invoice |
£0.00 |
£250.00 |
£250.00 |
1009119 |
| 05/01/2008 |
Payment |
£250.00 |
£0.00 |
£0.00 |
1009119 |
| 10/01/2008 |
Credit |
£150.00 |
£0.00 |
(£150.00) |
1009119 |
(It is usual to show minus figures, e.g. -£150.00 as (£150.00) since otherwise it can be too easy to miss the - and this would obviously have a big effect on your book´s totals!)
You can see from the above that there is now a balance of negative £150.00, i.e. we now owe Joe Bloggs Enterprises £150.00. So, we refund them this amount and add it to our book amounts:
| Date |
Transaction Type |
Credit |
Debit |
Balance |
Ref |
|
|
|
|
|
£0.00 |
Opening Bal |
| 01/01/2008 |
Invoice |
£0.00 |
£250.00 |
£250.00 |
1009119 |
| 05/01/2008 |
Payment |
£250.00 |
£0.00 |
£0.00 |
1009119 |
| 10/01/2008 |
Credit |
£150.00 |
£0.00 |
(£150.00) |
1009119 |
| 10/01/2008 |
Refund |
£0.00 |
£150.00 |
£0.00 |
1009119 |
Balance is restored!
In the same way that a Credit Note can effectively reduce the value of an Invoice, so a refund can effectively reduce the value of a payment received from a customer - and this is something which probably seems much more obvious to you: if a customer gives you £100.00, and you give it back (or refund it) then you have reduced their original payment to you to nothing.
If this is the first time you have looked at Invoices, Credits and Refunds it may all seem a little bewildering. That is why, even with basic bookkeeping requirements, it is worth using business management software to manage these things for you. Business Builder allows you to create Invoices, which you can easily print or email for sending to your customers. Once created, this invoice will automatically sit in your "Unpaid Invoices" folder. If you receive any payments against this invoice, you just add them in on the Invoice screen, and once the Balance Due drops to zero the invoice will automatically be removed from the "Unpaid Invoices" folder. Credits and refunds can easily be added where necessary - in fact the Order Management side of Business Builder will automatically create the required Invoices, Credits and Refunds based on items that are added, changed or deleted from the Order, meaning that you don´t even need to think about your books!
