Credit Memo: What is it and how can I better manage it?

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. 

What is a credit memo?

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.

Why do credit memos get 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:

• The seller sent the wrong material

• The seller accidentally overcharged the AP department

• The goods were damaged in transit 

• The seller was late in completing the delivery – and the buyer no longer needs the item

Why don’t credit memos get cashed?

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.

• Crouching credit, hidden memos: Not all credit memos get stored in the same way, and some only exist in an email hiding out in your inbox. If you can’t easily find them, your chances of using them are slim to none.

• Late to the game: If the six-figure credit comes in months after you’ve stopped using that vendor, imagine having to face the rigmarole of procurement for a one-off purchase using a credit memo. No thanks.

• Mismatched amounts: The six-figure memo is great to have, but your next purchase from the vendor is for half that. You’re now getting additional memos and you (and your systems) aren’t sure what to do with the original one for the total amount. Without a Marvel-esque memory, or sophisticated tech to keep track for you, you're on to a loser.

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.

The negative impact of not using up credit memos

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.

How to manage credit memos better

Better memo management rests on making them easier and faster to match to invoices. There are Accounts Payable departments already making swift work of it – with processes set up that automatically apply relevant memos to invoices. With solutions like Process Intelligence, more departments can follow that lead, gaining end-to-end visibility of the memo-management processes, live, and setting up automations powered by artificial intelligence. With that, teams can:

• See the total amount of open and aging credit memos across vendors and ERPs

• Prioritize outstanding memos by free cash flow and P&L impact

• Match memos to invoices by invoice number, and vendor and company code

• Apply an open invoice to a memo and communicate the changes to stakeholders

Find out Celonis co-CEO and co-founder Bastian Nominacher’s favorite credit memo management story in these six short slides.

And to learn more about making your memo management processes work for you, check out our video on reducing aging credit memos, and our guide to turning your shared services center into a value magnet.

Edward Baggaley

Content Marketing Lead

Edward writes about Celonis, its customers, partners, and product. He creates blogs - perhaps the one you’re reading - as well as ads, ebooks, keynotes, and advertorials. Newsweek, The Times, Time, and many B2B magazines have published his work.