No matter how hard you try to avoid it, there will be times when an invoice is not paid by a customer. Sometimes, this means that you have to chase up a late payment, whilst at other times, it means working out how to correctly account for an invoice that you know isn’t going to be paid.
In this post, we take a look at what you should do when you know you’re not going to receive a payment for an invoice and how to correctly record this in your invoicing software.
Cancelling an unpaid invoice with a credit note
Often, an invoice can be cancelled with a credit note. Simply put, issuing a credit note will let you enter a form of payment on an invoice that cancels out the amount that is due.
For example, if you issue an invoice for a language course and before you start to deliver the lessons, the student decides not to proceed, you can cancel the amount that is due with a credit note.
In the Debitoor system, you can create a credit note very easily. You just need to select the invoice that is not going to be paid by your customer and tap ‘⋮’, then ‘Create’, and finally ‘Credit Note’. This will automatically convert the total due on the invoice to a negative amount. Then, just tap ‘Complete Credit Note’ to save.
The credit note can then be sent to your customer to confirm that they do that the money owed has been cancelled. When you return to your invoices list, you will then see that the unpaid invoice will now be marked as paid, and you will have a new credit note in your credit notes tab, also marked as ‘matched’, with the same amount that you originally invoiced for.
When can you cancel an invoice with a credit note?
You can cancel the invoice with a credit note if:
- You have provided a product and it has been returned by the customer, or
- You have invoiced for a service which has not yet been performed
Recording an unpaid invoice as bad debt
At other times, even if you know you’re not going to be paid, it’s not possible to cancel the invoice. This is because you’re actually losing money, and it therefore needs to still be included in your accounting. If you provide a product to a company and they simply don’t pay, you shouldn’t cancel the debt that’s owed, but rather acknowledge this bad debt.
Simply put, bad debt is any money that’s lost by your business. It therefore counts as an expense. To record an invoice as bad debt, you need to go into the ‘Expenses’ tab and click ‘New Expense’. The full amount that is still owed by the customer should be written and you should add it to the expense category ‘Bad debt’. It can be found within the ‘Banking and Financing Costs’.
When you record your expenses, it’s also possible to add a photo or document. Here, it can therefore be a good idea to add a copy of the invoice that’s left unpaid. Not only is it helpful to know exactly which invoice it refers to, but it may also remind you not to do business with that customer again in the future.
When should you record an unpaid invoice as bad debt?
You have to leave the invoice unpaid and create an expense under the category ‘bad debt’ if:
- The service has already been provided to the customer, or
- The product has not been returned by the customer.
The reasoning behind this is that in both of these situations you have actually lost money. If you still have the product, it can always be resold to another customer, and if you haven’t yet provided the service, the indebted customer hasn’t benefitted from you. However, if the product has been lost or the service has been provided, the customer has benefitted from you and cost you money (and time).
How much should you record the bad debt as being worth?
You should always record the full amount that you’re owed as bad debt. If you provide a service which isn’t paid for, you should still account for the full cost of the bad debt, not just for the amount it cost you to provide.
For example, suppose you charge £25 per session for a private language lesson, and it costs you only £3 in fuel to drive to the student’s house. You should still mark the 5 unpaid sessions session as £125 of bad debt and not just the £15 it cost you to get there each time, as this is still time you could have spent with another student, and therefore earned money.