Credit memo vs. debit memo: An essential guide for small businesses

If you run a small business, chances are you deal with invoices, returns, and the occasional billing error. That’s where credit memos and debit memos come in. These small but important documents help keep your finances accurate and your relationships with customers and vendors on track.

In this guide, we break down everything you need to know about credit memos vs. debit memos, how they differ, and why they matter for small business owners.

What is a credit memo?

A credit memo, or credit note, typically includes key details like the invoice number, the date the credit is issued, and a description of relevant items. It also specifies the credit amount and the reason for the credit. A credit memo outlines the payment terms and any related purchase order numbers as well, making it easier to connect the memo to the original transaction.

When do businesses use credit memos?

Businesses typically use a credit memo when a customer owes less due to a return, discount, or adjustment on a current or past purchase. Here’s a closer look at why you may issue a credit memo:

• Returns and damages: When a customer returns goods or finds them faulty after a sale, you issue a credit memo to reduce the accounts receivable and reflect the adjustment
• Billing or pricing errors: If there’s a mistake in invoicing, like an accidental overbilling or a missed promotional discount, a credit memo corrects the error and keeps financial records accurate
• Customer issues: Issuing a credit memo helps maintain good customer relationships by showing your commitment to fixing any problems, whether it’s a mistake or customer dissatisfaction
• Inventory management: Credit memos track product returns, which helps ensure your inventory levels and financial records stay in sync

Customers can use the credit for future purchases or apply it to a refund. The credit memo serves as a useful record for both the buyer and you as the seller.

How do credit memos impact your finances?

Credit memos play a key role in maintaining accurate financial statements and are an important part of your month-end close process. When you issue a credit memo, it reduces the amount a customer owes, which directly impacts your accounts receivable balance.

It can also affect revenue recognition, since lowering the sale amount may change the recording of that revenue on your income statement.

What is a debit memo?

Similar to the credit memo, a debit memo includes details such as the invoice number, the date of the debit and the debit amount, a description of the items, and the reason for the adjustment. You’ll often find payment terms and related purchase order numbers as well.

When do businesses use debit memos?

After an initial invoice, you might issue a debit memo to adjust a customer’s account for additional charges or corrections. Some common reasons for using a debit memo include:

• Supplier overcharges: When a supplier bills for more than the agreed-upon price or quantity, the buyer may issue a debit memo to reduce the accounts payable, correcting the purchase price variance
• Fee assessments and penalties: Charges such as late payment penalties or interest on overdue amounts sometimes require the issuance of a debit memo to communicate the additional expenses
• Underbilling corrections: If you accidentally undercharge a customer, whether due to a miscalculation or a missing line item, a debit memo helps adjust and collect the correct invoice amount
• Additional services or costs: Should a client request extra work or if new expenses arise after the original invoice, a debit memo can account for those charges and update the billing accordingly

How do debit memos impact your finances?

Debit memos play an important role in adjusting your financial records. A debit memo impacts accounts payable by updating the balance to reflect any additional charges or reductions from previous purchases. It also affects expense accounts, as the memo aligns with new costs or adjustments.

Key differences between credit memos and debit memos

While both documents serve to rectify financial records, their operational motives and impacts are subtly distinct. Here are a few key differences between debit memos vs. credit memos.

Why credit and debit memos are important for small businesses

Credit and debit memos play a crucial role in the day-to-day operations of your small business.

For example, a small bakery owner might issue a credit memo to correct an overcharge and keep a loyal customer, while a farmer might use a debit memo to address an under-delivery of produce and update their account accordingly.

If you don’t handle these financial transactions correctly, it can lead to inaccurate record-keeping, affecting your decision-making and potentially causing operational problems. You’ll need to understand and manage credit and debit memos to keep your business’s finances in check and ensure accounting stays agile and accurate.

How Ramp helps you track credit and debit memos

The daily operations workflow of a small business can be chaotic, especially with a stack of credit and debit memos to manage. Ramp’s expense management software simplifies and streamlines small business accounting tasks for you, including the tracking and reconciliation of credit and debit memos.

Our platform automates much of the accounting process and gives you real-time insights into your financial picture, from spending to cash flow. This means more time to focus on your customers and grow your business.

Learn more with our free, accountant-approved guides, examples, and templates for credit memos and debit memos.

FAQs

Is a credit memo the same as a refund?

A credit memo is not the same as a refund, though they are related. A credit memo reduces the total amount a customer owes, often for future purchases. A refund returns money directly to the customer.

Is a debit memo a refund?

No, a debit memo is not a refund. It’s a document that increases the amount due for a customer, typically because of underbilling, additional charges, or adjustments to previous transactions.

Can a credit or debit memo expire?

Credit and debit memos don’t have a formal expiration date, but it’s important that customers use them within a reasonable timeframe. Over time, they may become harder to reconcile and less useful during audits.