What Is a Credit Note (Credit Memo)?
A credit note — also called a credit memo — is the document you issue to reduce or cancel an invoice you've already sent. Maybe the client returned goods, you overbilled by mistake, or you agreed a discount after the invoice went out. Instead of editing or deleting the original invoice, you issue a credit note that formally records the reduction.
This guide covers when to issue a credit note, why you should never alter an invoice once it's issued, what a credit note must contain, how it settles, and what it does to the tax on the sale — with a worked example of a partial credit.
When to issue a credit note
You issue a credit note whenever an invoice you've already sent turns out to be too high — or shouldn't exist at all. The common triggers are a client returning goods, a quantity or rate you overbilled, a discount or goodwill reduction agreed after the invoice went out, work cancelled after invoicing, or a plain error such as the wrong client, the wrong amount, or the wrong tax.
A credit note works in one direction only: it reduces what the client owes. If you undercharged, you don't issue a negative credit note — you issue an additional invoice for the difference, which in some countries is called a debit note.
Why you never edit or delete an issued invoice
Once an invoice has left your hands, two copies of it exist — yours and the client's — and your books are only credible if they match. Quietly editing your copy breaks that match. Deleting it is worse: many jurisdictions expect invoices to run in an unbroken sequence, and a deleted invoice leaves a hole in the sequence that reviewers read as a sale removed from the books.
A credit note solves this cleanly. The original invoice stays in the sequence exactly as issued, and the credit note sits alongside it as a second, equally traceable document recording the correction. An auditor, a bookkeeper, or you in two years can follow the full story: what was billed, what was credited, and why.
The one exception is an invoice you never actually sent. A draft can be fixed or discarded freely — the audit trail only starts once the document is issued.
What a credit note contains
A credit note looks a lot like an invoice, and deliberately so — it's the mirror image. It carries its own unique number, usually from a separate sequence such as CN-001, its issue date, and both parties' names and addresses, just as the original invoice did.
Two fields do the real work. First, a reference to the original invoice — its number and usually its date — so anyone can pair the two documents. Second, the reason for the credit, stated plainly: goods returned, overbilled 10 hours at $80, order cancelled. Some tax authorities require a reason, and it's useful even where they don't.
Then the numbers: the amount credited, shown line by line if only some items are affected, plus any VAT, GST, or sales tax on the credited amount at the same rate the original invoice charged. If you credit $500 that was taxed at 10%, the credit note shows $500 plus $50 tax, $550 in total.
Partial vs full credits: a worked example
Say you sent INV-051 for $3,000: $2,500 of design work and a $500 print run. The print job falls through, but the design work stands. You issue CN-007 referencing INV-051, crediting $500 plus the tax charged on it, with the reason stated as print run cancelled. The client now owes $2,500 plus tax, the original invoice is untouched, and the two documents together tell the whole story.
A full credit cancels the invoice entirely — same mechanics, whole amount. You'd use one when the order is cancelled outright or the invoice went to the wrong client. If a corrected invoice is needed, issue it under a fresh number; never reuse the number you just credited.
How a credit note settles
A credit note creates value the client can use, and it settles in one of three ways. If the original invoice is still unpaid, the credit offsets it directly and the client simply pays the reduced balance. If the invoice was already paid, you either refund the credited amount or, with the client's agreement, hold it as a credit against their next invoice.
Whichever route you take, record it. A credit note left dangling — issued but never offset, refunded, or applied — is the kind of loose end that makes reconciliation painful months later. Note in your records how and when each credit note was settled.
What it does to VAT, GST, or sales tax
If you charge VAT, GST, or sales tax, a credit note doesn't just reduce the sale — it also reverses the tax charged on the credited amount. You reduce the tax you owe to the tax authority, and in VAT and GST systems a registered client reduces the input tax they reclaimed on the purchase. That's why the credit note must show the tax separately, at the original rate.
The details are local. Some countries prescribe exactly what a tax credit note must contain, how soon it must be issued after the price changes, and which return period the adjustment belongs to. If you're tax-registered, check the rules where you're registered before relying on the general picture here.