Writing off credit memos is a little like turning on the incinerator when there’s cash inside. Learn what credit memos are, why companies create them and how to cash in every single one.
We’re all guilty of it: we buy something, return it for store credit, and then swiftly forget about the store credit. The same goes for business-to-business transactions. Sellers apply a credit memo to a future purchase but the buyer never takes them up on it. Money down the drain.
It's time to make more of credit memos – here's what you need to know to manage them better.
So what is a credit memo? A credit memo, short for credit memorandum and occasionally known as a credit note, officially acknowledges a customer is owed money. That money can be applied to future purchases of goods and services.
How is it different from a refund? Glad you asked. It's different because it provides credit for a future invoice amount, not cash, to the customer account.
It contains important information, including: the purchase order number, date of purchase, original invoice number, corresponding invoice date, payment terms, billing details, buyer shipping address, prices, quantities, and more. It will also include the reason it was created and issued.
You unbox the sneakers, slide them on awkwardly, wiggle your toes around, and realize you’ve made a mistake — a pretty big one, literally, since they are, in fact, way too large.
Sometimes it's size, other times it’s color, and sometimes you simply change your mind within 30 days. We return things for all sorts of reasons. For business goods and services, it’s a similar story.
Here are some top reasons – there are many more – that would lead to the issue of a credit memo for a future invoice and future purchases:
We’ve established what a credit memo is and the common reasons they get issued – now for the reasons they can go unused.
Approximately $3 billion worth of gift cards go unused every year in the United States alone. Since we’re talking about business services, not the latest dunks, the dollar value of unused credit memos is likely to be far higher. So, what gives?
Let’s go through a simple scenario to get to the bottom of it. Picture this: you’re working in the Accounts Payable function for a Shared Services Center and your vendor sends you a credit memo for the value of the goods you returned. There's a nice, accurate six-figure credit amount in the financial records of your customer account. This is where problems can start – here are three common reasons why.
When standards can be ill-defined, human grit and determination isn’t enough. Teams and departments that can’t successfully make credit memo transactions end up moving to higher priority tasks on the to-do list instead – with negative results for the business.
When teams don’t use a credit memo within a certain time period – typically 12 or 18 months – internal systems tend to automatically classify it as uncollectible and write it off.
Outstanding credit memos that go unused have consequences: the company takes on bad debt and sees its cash-flow and P&L negatively impacted. Handily, we’ve already discussed four quick levers to improve cash-flow management, which you can read here.
