What is a credit note?

Business transactions don’t always go according to plan. Products arrive damaged, services need to be adjusted, and errors sneak into invoices. This is where credit notes come in. But what is a credit note, exactly?

A credit note is a straightforward and essential business document that helps keep your financial records accurate and your customers happy. Here, we’ll explore everything you need to know about credit notes, including how they work and when to use them.

Let’s dive in.

What’s a credit note?

A credit note is a formal document that businesses issue to customers to cancel out or reduce part of an existing invoice. You might think of it as the opposite of an invoice: instead of requesting payment, a credit note confirms that money is owed back to the customer.

Businesses typically issue credit notes when they need to make adjustments to a previous sale. This might happen if:

• A customer returns faulty goods
• The original invoice contains an overcharge
• The wrong items are delivered
• A discount needs to be applied after the initial sale

The credit note contains much of the same information as the original invoice, including a unique reference number, the amount being credited, and details of the original transaction.

What is the purpose of a credit note?

Credit notes perform several important financial and legal functions:

• They legally amend incorrect or disputed invoices: Rather than voiding the original invoice (which could cause accounting complications), a credit note creates a clear audit trail of the adjustment.
• They play a crucial role in VAT accounting: When you reduce or cancel a sale, you must also adjust the VAT. Credit notes ensure these adjustments are properly documented and reported to HMRC, helping you stay compliant with tax regulations.
• They help maintain positive customer relationships: By providing a professional and systematic way to handle returns, refunds, and billing adjustments, credit notes reassure customers that they’re working with a bona fide business and that their financial concerns are being formally addressed.
• They’re valuable for financial reporting and analysis: Credit notes help businesses track patterns in returns, discounts, and billing adjustments, which can help to improve products, services, and business processes.

Is a credit note a refund?

No, a credit note isn’t the same as a refund, although they’re closely related.

A credit note is an acknowledgement of money owed. This amount can be handled in several ways, including being applied against future purchases, being used to reduce the amount owed on other outstanding invoices, or converted into an actual refund.

A refund, on the other hand, is when money is physically returned to a customer in cash, via bank transfer, or by reversing a card payment.

Whether you choose to issue a credit note or a refund will likely depend on your company’s policies or the circumstances at play. Many businesses prefer to issue credit notes rather than immediate refunds because they:

• Encourage customers to make future purchases
• Reduce administrative work and banking fees
• Help maintain cash flow management
• Provide more flexibility in how the adjustment is handled

Some customers opt for credit notes over refunds if they regularly make purchases from a particular company. A credit note saves the hassle of processing multiple payments and is often an efficient solution for both parties.

How does a credit note work?

When you issue a credit note, you’re effectively establishing an official paper trail of an adjustment. Your credit note must clearly show the amount being credited and must have a link to the original invoice. The credit note then works in one of several ways:

If the customer has already paid the original invoice:

• The credited amount can be kept on account for future purchases
• It can be refunded directly to the customer’s bank account
• The customer can choose to apply it against other outstanding invoices

If the customer hasn’t yet paid the original invoice:

• The credit note can reduce the amount they need to pay
• They can deduct the credited amount from their payment
• The original invoice and credit note can be matched in the accounting system

When should I issue a credit note?

As a business, you should issue a credit note whenever you need to reduce or cancel out a previously issued invoice. Here are the most common situations in which this might be necessary:

When goods are returned:

• The customer returns faulty or damaged products
• Items were delivered in error
• The wrong quantity was shipped
• The customer changes their mind (if your returns policy allows this)

When there are pricing errors:

• The original invoice had incorrect prices
• A discount wasn’t properly applied
• There was a calculation error
• The wrong VAT rate was charged

For service-related adjustments:

• A service wasn’t delivered as promised
• The customer was overcharged for services
• A project was cancelled after invoicing
• A subscription or contract ended early

For administrative corrections:

• The customer’s details were incorrectly noted on the invoice
• There were duplicate charges
• The wrong items were listed on the invoice
• A promised discount needs to be applied retrospectively

It’s important to note that, in the UK, you must issue a credit note within 14 days of agreeing to the price reduction or return with your customer. This helps maintain accurate VAT records and ensures compliance with HMRC regulations.

You can find more about HMRC’s credit note regulations on the gov.uk website.

What happens when you receive a credit note?

If you’re a customer, you have several options available to you when you receive a credit note. There are also some important steps you should take to handle it properly.

Start by carefully checking the credit note to ensure all the details are correct:

• The amount must match what you’re expecting
• The original invoice number must be referenced correctly
• Your personal or company details must be accurate
• The reason for the credit note must be clearly stated

Once you’ve confirmed everything is correct, you typically have three main options:

• Use it towards another purchase in the same shop
• Request a refund to your original payment method
• Keep it to use later (but check if there’s an expiry date)

It’s important to keep the credit note safe until you use it — treat it like a gift voucher. Most shops will ask to see the original credit note or at least need the reference number when you want to use it.

If you're shopping online, the credit note might come in the form of a digital code or it might be automatically added to your account. Either way, make sure the shop clearly explains how you can use it.

Remember, while businesses might prefer you to use the credit note for future purchases, as a consumer you usually have the right to ask for a refund instead, especially if the goods are faulty.

Quickfire summary: What is a credit note in the UK?

A credit note is an important document that helps to handle financial adjustments, whether you’re accounting for returned goods, changes to the services you offer, or pricing corrections.

While credit notes and refunds are closely related, they’re not quite the same thing. A credit note offers flexibility in how an adjustment is handled. It can be applied to future purchases, used against outstanding invoices, or converted into a refund if needed. This makes it an easy, efficient, and legally compliant way of managing your business transactions.

When you issue credit notes, always remember to check the details carefully, manage your records well, and communicate with your customers. Good credit note management isn’t just about maintaining accurate books — it’s also about ensuring that your customers trust you and enjoy working with you, even if adjustments need to be made.

Also read:

• What’s the best app for invoicing? Top 7 picks
• What is Making Tax Digital in the UK?
• When does the tax year start in the UK?

Are you looking for insurance cover to support your business? Get in touch with us! A member of the Howden team would love to help you find the perfect policy!

Get a Quote

READ MORE BUSINESS INSURANCE GUIDES