Credit Note Definition and How it Relates to your Business

Have you ever bought something you later regretted? Maybe it was damaged, or didn’t live up to your expectations. If you did and then decided to later return it, you receive what’s called a “credit note” in exchange. Credit notes are actually pretty important for a company’s accounting books, so let’s take a look at it!

In purely accounting terms, a credit note is a physical or electronic commercial document issued to mark a return of funds. Most of the time this happens when a customer returns a product that they didn’t like or they thought was damaged. Although that might be the most common case, a credit note case can also be issued in the event of an invoicing error, if somebody cancels their order or some other event specified in the terms of purchase.

A credit note is issued so that the company and customer can adjust their books. Although customers don’t usually pay as much attention to their books as companies do.

👆In accounting a credit note would be recorded as a debit under revenues and credit in accounts receivables.

Building on the last section, credit notes are given out when a customer either returns a product, cancels an order, or is refunded for some other reason. There are two main types of credit notes:

• Ones that are issued for payments coming in
• Ones issued for outgoing payments

What this means is that businesses can give out and receive credit notes, meaning they can give refunds and be refunded for things they’ve bought.

Here are the main situations where a credit note should be issued:

• Correct an invoice
• Cancel an order
• Give out a refund for damaged goods
• Or just general product returns

Credit Note Examples

To illustrate the concept a bit better we’ll go through a couple of credit note examples.

Example 1

A manufacturer orders raw materials from a supplier, but the supplier bills the manufacturer too much. So the supplier issues a credit note for the excess amount charged.

Example 2

Let’s say company A pays company B a specific amount for services or goods. If company B wants to buy something from A, they can use a credit note for future orders. Or if they haven’t paid yet, and they want to order something, they can use the credit note and then the outstanding invoice is cancelled.

Example 3

The easiest and most common example of credit notes is when a customer buys a product, then they realize they don’t like it or there’s some sort of problem with it. The customer takes the product back and then they’re debited and the company's accounts receivable is credited.

As we mentioned a little before, the accounting side of credit notes is extremely important. After issuing a credit note you need to adjust different parts of your balance sheet. For example, if a customer returns a product, the company should add a credit in the sales book for that specific customer.

Keeping your books in balance is an essential part of your business. If something’s recorded wrong it has a subsequent impact on the decision-making of the business and pretty bad consequences.

Most of the time you won’t actually need to record the credit note in an actual book, but rather an accounting software. To find the best accounting software for you and your business, click here.

A critical part of any commercial business is returns, sometimes things don’t go right, or a customer just doesn’t like the product. Sometimes you make an error on an invoice or bill. Knowing how to deal with those things is a critical part of your activity.