Every business must be paid for the products or services rendered. Otherwise, how would you survive?
The more streamlined the payment process is, the better the cash flow. Facilitating transactions leads to a higher rate of growth, stronger business relationships, and tighter controls.
There is one single document that gets the entire process rolling. That’s called an invoice.
Invoice Meaning
An invoice is an itemized list of all products or services and their total costs provided by a vendor and received by the customer. An invoice keeps a record of the products and/or services rendered, and other important details like the date, amount due, and method of payment.
Invoices can be transmitted in a variety of ways, including paper or electronic. Most customers prefer to pay electronically, and modern systems are built to accommodate them.
After the product/service has been delivered, the invoice goes out. This is to notify the buyer of exactly what is owed and when it is due. Payment terms are also clearly stated, so the buyer knows how long they have to complete the transaction.
Invoices can be paid in full or through installments. Subscription-based companies often bill customers at a specific time each month and automatically withdraw funds from the corresponding bank account via accounting software.
What Does an Invoice Do?
An invoice is a document that tracks what a customer owes a business. They can be used as a way to monitor cash flow and help companies receive payment in full and on time. They serve as a record of sales and provide a way to track important metrics, like:
- The sell date of the goods and/or services
- How much you charged for the sale
- Any outstanding balances the customer owes
Additionally, invoices will help protect your business in the event of an audit. It shows the IRS exactly where your money comes from should they question your tax returns.
For the seller, the invoice is entered as accounts receivable. After invoice payment, it’s an accounts payable entry for the buyer.
Invoices and Accounts Payable
Invoices are a tool to help keep track of accounts payable. They track the sale of a product for better inventory control, accounting, and tax purposes. Since companies typically ship a product and expect payment at a later date, the total amount due turns into the accounts payable for the buyer and accounts receivable for the seller.
Invoices are different from purchase orders, which are created before a customer orders something. Modern invoices are transmitted to the AP department electronically rather than on paper. The use of an invoice in AP represents the presence of credit, since the seller has sent the product without cash upfront.
Invoices and Internal Controls
Invoices are essential for managing internal controls for accounts payable. The charges on an invoice must be approved by the proper parties before payment is made. At times, it must also be matched with the corresponding purchase order, shipping receipt, and/or inspection report. An auditing team ensures invoices are entered into the right accounting period when testing for expense cutoff.
Creating an Invoice: Step by Step
If you want to create a professional invoice that stands up to audits and streamlines the payment process, consider the following steps:
#1) Use Clear Language
Customers should always know that they’re receiving an invoice. Simply adding the word “invoice” will prompt buyers to take the document seriously and pay on time, as the label makes it stand out from other documents in the pile. In some cases, it’s the law to include clear language.
Additionally, the invoice needs to have a unique number assigned for identification purposes. This is to ensure no duplicates are created, and makes for a much smoother reconciliation process.
When it comes to an invoice number, use a sequence that gradually increases. You can also use letters in front of a number to indicate a specific client or job.
#2) Professionalism
Make sure the document looks professional. This includes matching fonts, accurate calculations, and branding in the proper places. If you’re not sure how to create the format for an invoice, there are hundreds of free invoice templates online.
There may even be some in your word processor, depending on the program you use. Microsoft Word has plenty of invoice templates for users.
#3) Contact Information
This includes the information from both the buyer and the seller. The invoicing process should always include the following:
- Your company’s name, address, and contact information
- The customer’s name, address, and contact
- Any specific names or addresses for the accounts payable department
#4) Describe the Goods and Services
This doesn’t need to be long, but it should include enough information so the customer can easily identify what they are paying for. Make sure to include quantities and amounts, as this can be an area of invoice dispute that leads to delayed payments.
Here’s a quick checklist of what to include in your product/services section:
- The date any service was completed
- A description of services/products that specifies the unit level
- Total number of units and rate
- Total amount due
- Any applicable tax
#5) Adding Dates
Make sure you add all essential dates as well. This includes:
- The date the invoice was created
- The date the goods/services were provided
The invoice data should always be at the top. The date the goods/services were provided can be in the description.
#6) Calculating What is Due
This is the most important part of the invoice. In addition to the costs of individual goods and services, you must put the total amount owed. If you’ve agreed to an early payment discount with the customer, this should also be noted on the invoice and subtracted from the cost. If it’s applicable, include the VAT amount too.
It’s optional to also include a notation of late fees on the invoice. This way, if you intend on collecting them, it’s not a surprise to the customer.
#7) Mention the Payment Terms
Payment terms are agreed upon with the customer during the initial contract period. However, the payment terms should be noted on the invoice as well. If you expect to be paid within a certain time period, remind people by stating that clearly.
The invoice can also include the types of payment methods you accept. If you want the customer to pay directly to an account, you may want to add those details as well.
The more information included on an invoice, the easier it is for a customer to pay you. This helps maintain positive cash flow and strengthens business relationships.
What’s Included in an Invoice?
Invoices are not standardized and can vary by vendor. However, every invoice on the planet must include these four components to be considered a financial record:
A Unique Identifier
An invoice number must be assigned to every invoice you issue. This is a reference number that helps establish a paper trail for a company’s accounting records. Invoice numbers should be assigned in sequential order, so that every number on a new invoice is higher than the last. Some companies also associate the invoice number with the corresponding purchase order.
Dates
The invoice date indicates the date and time a vendor creates and sends the invoice. This is also when the transaction is officially recorded in the books.
This is a crucial piece of information as it will also dictate the invoice due date, which is based on the pre-agreed-upon payment terms. This is generally 30 days, but some industries, like manufacturing or logistics, require longer payment cycles. The shorter the cycle, the quicker you get paid.
Contact Information
All invoices must contain contact information for both parties. This includes the name, address, phone number, and email.
Descriptions of Goods and Services
Every product or service provided must be entered as a line item on invoices. Each line item must also include the price and quantity.
At the bottom of the invoice, there must be a subtotal and another line for tax. Under that, the grand total due should be highlighted or put in bold.
Payment Terms
To increase the likelihood of being paid on time, the invoice should provide clear details about payment expectations. The payment terms specify the amount of time the buyer has to pay for the transaction.
Choose terms that encourage early payment to maximize your cash position and keep a healthy cash flow. You may choose to collect partial payments over time to keep from receiving late payments.
When setting payment terms, you can consider a customer’s credit history, especially for larger sales. Then decide how long your customer needs to settle the invoice. Net 30 is the most common term of payment for invoices. This means the buyer has 30 days from the invoice date to settle the transaction.
Common Payment Terms
If you’re trying to decide on payment terms for customers, there are a few different ways you can go. Consider some of these common styles of collecting payment:
Upon Receipt
This is when you ask for payment as soon as the buyer receives the invoice. You don’t have any expectation of payment until the client has the invoice in hand.
Payment in Advance (PIA)
As it sounds, this is when a business asks for payment in advance for the goods or services rendered. Essentially, you are asking customers to pay invoices in full before you work. This is a slippery slope and should only be done in extenuating circumstances.
Cash in Advance (CIA)
When you ask for cash in advance, it’s the same as payment in advance. You want the funds before goods/services are delivered.
Net X
In this instance, you’re asking customers to pay X number of days after the invoice date.
15-Month Following Invoice (MFI)
When you ask a client for MFI payment terms, it means you’re asking them to pay by the 15th of the month, following the date of the invoice. So if you invoice on March 3, the invoice would be due March 15th. If you invoice on March 17th, it wouldn’t be due until April 15th.
End of Month (EOM)
These are payment terms that request customers pay at the end of the month, indicated by the invoice date. So if the date is April 10th, the invoice would be due by the end of April.
2/10 Net 30
When you ask for 2/10 net 30, you’re asking customers to pay within 30 days of the invoice date. However, if clients pay within 10 days, they will receive a 2% discount. This encourages early payments and keeps your cash flow positive.
50% Upfront
Just as you would suspect, indicating 50% upfront is asking clients to pay for half of the job before the work has begun. This is a common setup for large jobs that are expected to take a while, like construction.
Types of Invoices
A business can issue different types of invoices to a customer depending on the purpose and timeline of a project. Here are some of the more common invoices used during the payment process:
Interim
An interim invoice is issued when a large project is taking place and needs to be billed across multiple payments. They help a business manage cash flow by allowing them to collect payments during the course of a large project.
Interim invoices can help cover the costs associated with ongoing work, rather than waiting until everything is completed. It also keeps cash flow healthy and helps a small business better prepare for unexpected issues that may occur during the job.
Pro Forma
Pro forma invoices are sent to a customer before a product or service is delivered. They can be used to help customers better understand the cost and scope of an upcoming project.
This type of invoice is always sent before a formal invoice and is more of an estimate or informal quote, than it is an actual invoice. The terms in a pro forma invoice can also be adjusted as a project progresses, but they are always a helpful tool to ensure everyone is on the same page price-wise.
Recurring
A recurring invoice is issued to collect repeated payments from customers. They are typically issued throughout the course of a project, like when a consulting firm bills on a monthly basis for ongoing services.
This is most helpful when the amount is the same every month and the same type of invoice needs to be sent. Electronic invoices or invoicing software is ideal in this situation as it can automate the entire process for you.
Debit
A debit invoice is issued when a business needs to increase the amount a client owes on goods or services delivered. This happens when the scope of a project increases, services are underbilled, or you work additional hours after sending an invoice. In this case, a debit invoice can be issued as record-keeping for the difference.
Credit
If a business needs to provide a customer with a discount or refund, a credit invoice can be issued. In this case, the document will include a negative amount (not request payment) to cover the cost of what was returned. This can happen if you accidentally overbill a client. The credit invoice provides documentation of the amount refunded.
Past Due
This is an unpaid invoice that’s now past the due date. These invoices can be sent in a different color for more attention. Past-due invoices will negatively affect cash flow and collecting on these can cost time and energy.
Creating invoices with clear language and offering early payment discounts are two ways to avoid having the create a past-due invoice in the first place. The ultimate goal is to encourage timely payments on the initial invoice.
Commercial
A commercial invoice is typically created when there are international transactions involved. They are considered customs documents to be used when a company is exporting goods globally. The information you include on commercial invoices will be used to calculate tariffs, so it’s vital that everything is accurate.
Although there is no standard format for commercial invoices, they must include specific data, like:
- Contact information of both parties
- Good being exported and the reason why
- The country or territory of origin
- Description of goods being shipped
- Number and value of units
- Total weight and number of packages
A Harmonized System code will be assigned to the goods being shipped, which should also be included on the commercial invoice. The shipper’s dated signature is also required.
The Most Common Questions About Invoices
When it comes to creating, understanding, sending, and processing invoices, there are a lot of questions. Here are just a few:
Is an invoice a receipt?
They are not the same. An invoice is issued to collect payments, whereas a receipt is issued as proof of payment. When you are sending a receipt to a customer, they have already paid their invoice. A customer may request both for tax filing purposes.
When should invoices be issued?
As soon as you complete an order, project, or service, a sales invoice should be created and sent out. Failing to invoice quickly can lead to delayed payments and a higher DSO (days sales outstanding). It also leads to a lower rate of accounts receivable efficiency.
How long should you give someone to pay an invoice?
Always define clear payment terms during the initial contract, and you won’t have as many problems later down the road. Net 30 (30 days) is the most common timeframe to collect on, but choose payment terms that make sense for your business.
Invoices work only when both parties are on board with the information they contain. The complexity and cost of a project may also factor into the payment terms.
Are invoices legal documents?
On their own, an invoice is not a legally binding document. They must be matched up with shipping receipts, purchase orders, and contracts. The contract signed by both parties, before any invoice is sent out, is really the top legally binding contract you have with a customer. These are legal documents that reduce misunderstandings and help speed up the payment process.
Summing it Up
Invoices are an essential bookkeeping tool for business owners that are used to document sales. Crafting clear, concise, and informative invoices benefits all parties involved. It also enables a business to appropriately represent itself to the IRS in the event of an audit.
Whether you’re an enterprise or a freelancer, invoices increase the likelihood you are paid on time, every time. This keeps your business growing, cash flow positive, and all the records in the right place.
