Credit Memo vs Invoice: A Complete Comparison Guide

Accounting is a broad field and it's okay if you don't know everything. Especially if you are just starting your business. And not only you but 60% of business owners like you are not confident about their accounting knowledge.

And that is mostly because it is quite a steep learning curve for small business owners and especially for contractors. Therefore, we should take one step at a time. And today, it is credit memo vs invoice. Let's learn the difference, the similarity, and how to use both for the most effective accounting process without investing in accounting software.

Table of Content

1. Understanding Credit Memos and Invoices
2. When and How to Use Each Document
3. Key Differences and Similarities Between Credit Memo and Invoices
4. Conclusion
5. FAQ

So, if you want to differentiate any two things, you must learn both of them inside out separately. Hence, let's learn what a credit memo and an invoice are, individually.

Understanding Credit Memos and Invoices

Before we begin with our guide, let's break down the idea of credit memos and invoices followed by the key components of both.

What is a credit memo?

The term credit memo is the abbreviated form of the credit memorandum. It is also known as a credit note.

The textbook definition of the credit memo is an accounting document that is issued by the seller to the customer to notify them of their positive balance in the account.

In simpler words, whenever the customer has paid more than the worth of services or goods he/she got, the company issues a credit note to reflect the same.

Now, you must be thinking what are those scenarios that create a need for issuing credit memos, right?

So, let's discuss when you need to issue credit memos.

When to issue credit memos

Your accounts payable department needs to create credit memos in many situations. So, you must know when to issue credit memos.

• When your customer returns goods or disagrees to avail your services, and demands a refund.
• When the prices drop and the customer has paid advance payments.
• When you want to settle pricing disputes.
• When the scope of the service gets modified resulting in reduced accounts receivable balances for you.

Basically, whenever the seller owes money back to the customer, the seller needs to create a credit memo. You can use a credit memo maker to quickly prepare credit memos.

But can't he/she just tell the customer about the same thing over a phone call? Umm no! And here's why.

What's the purpose of credit memos?

Well, that's right that the contractor can simply inform about the positive credit balance over a phone call but that's not the only purpose of a credit memo. So, let's know more about it.

Now, if you have understood the concept of credit memos, let's talk about the invoice.

What is an invoice?

An invoice is a legally binding accounting document that is issued by the seller to the customer for requesting the payments for the goods/services provided. While this is the primary purpose, it has multiple secondary purposes too, which we will discuss in this blog shortly.

An invoice helps the customers know how much they owe to the vendor, what they need to pay, when they are expected to pay, and how to pay the due.

Therefore, an invoice is mandatory to produce for every business transaction.

When to issue invoices

A contractor needs to create and send invoices at several instances during the time of the contract. This highly depends on the contract and the prior agreement between you and your client.

However, we will discuss the most common times to send invoices and you can choose the one which suits your business.

In a nutshell, it is issued whenever the vendor wants to request money. Now, if you want to save time and get them approved quickly, make invoices online.

What's the purpose of invoices?

Creating an invoice is among the first things accountants need to learn because it has multiple purposes that can benefit the business and the client. So, let's learn a few of them.

• Bookkeeping: Invoices are recorded for bookkeeping and keeping track of business sales.
• Accounting records: Invoices help in recording your business transactions and managing the accounts tally.
• Legal purpose: As invoices are law binding, you are supposed to make professional invoices to avoid a lawsuit against your business.
• Managing Inventory: An invoice records the product/goods sold and thus, you exactly know how stocked your inventory is.
• Brand marketing: An invoice is a great place to market your brand. You can mention all your services, brand logo, and contact details. It helps a lot in boosting customer loyalty.

Now that we have discussed credit memos and invoices separately, let's compare them next to each other and know the difference.

When and How to Use Each Document

There is no denying the fact that both invoices and credit memos play a vital role in business accounting. However, they both serve a very different yet crucial role. As a result, it is very important to understand the implications of both documents to avoid misunderstandings and maintain accurate financial records for your business.

Credit memo usage guidelines

A credit memo is typically used in the following situations:

• Product returns: In case of a product return, the credit memo adjusts the reduced balance.
• Billing errors: A credit memo reduces the overall amount if a customer is overcharged.
• Discounts or allowances: This document also helps to promote exclusive discounts and promotions for qualified customers.
• Customer satisfaction: Credit memos also help businesses to resolve customer issues and compensate accordingly.

Step-by-step credit memo creation

Creating a credit memo accurately is essential for maintaining precise records. Here's a step-by-step guide:

Invoice implementation best practices

Invoices are essential for requesting timely payments and clarifying the terms of a sale. Best practices for issuing invoices include:

• Timely delivery: To encourage prompt payment, send an invoice as soon as the product is shipped.
• Clear itemization: Avoid any confusion by clearly describing the product names, quantities, and prices.
• Set clear payment terms: If any, do not forget to mention due dates in the invoice. Also, mention any late fees so the clients know when and how to pay.
• Use consistent numbering: For easy reference and categorization, use the proper numbering style in every invoice.
• Maintain a professional tone: A professional, polite tone helps build trust and encourages positive client relationships.

Creating professional invoices

A professional invoice improves payment speed and reinforces your brand's reliability. Here's how to create an effective one:

Key Differences and Similarities Between Credit Memo and Invoices

Let's explore the key differences and similarities between credit memos and invoices, two essential financial documents used in business transactions.

Format and content differences

Document purpose comparison

Yes, they have quite a few differences.

But, both have similarities too. And that's why most contractors are confused between them.

So, let's talk about the similarities.

Alright, we have discussed the differences and similarities between both accounting documents. Now, you can easily differentiate between the two and know what to issue and when to.

And just to make sure we cover all your doubts, we have answered the frequently asked questions to help you clarify your doubts if any.

Conclusion

Both the buyer and the seller must know the difference between a credit memo and an invoice. Especially contractors like you. Because you have to issue the appropriate documents at the appropriate time to be professional.

So in this blog, we talked about the differences and similarities between a credit note and an invoice.

If this is too overwhelming for you as a contractor, you must try InvoiceOwl —estimating and invoicing software for contractors. You get a free trial without any commitment. So, sign up to InvoiceOwl now to win more jobs and get paid faster.