Apr 24, 2022

What Are Invoices?

by Arielle Kushner

what are invoices

An invoice is an official document issued by the seller to the buyer when requesting payment. It includes an itemized list of everything purchased, including costs and quantities.

Almost everyone is familiar with paper or e-mail receipts after purchasing from stores and websites, but the truth is that the invoicing process for businesses is a lot more complicated. Invoicing is a vital component of any financial management strategy. Accounts payable and receivable departments must use the accounting data from invoices to handle internal controls and financial auditing. Approval workflows for invoices also take some effort to streamline so that the right stakeholders can verify transactions before they happen.

Invoices are a perfect opportunity to gain vital financial insights. If organizing all your business’s purchases and sales is proving to be difficult and you fear missing out on important metrics and data analytics, it’s about time to start working on your invoicing procedures.

What Are Invoices: The Basics

Almost all industries work with invoicing regularly, from construction contractors billing for handiwork to artists making sales on their paintings to consultants charging for professional services rendered.

Whenever a seller officially organizes a sale with a third-party client, they write up a document known as an invoice that serves a few basic functions:

  • Identifying and listing out the products and services being purchased
  • Indicating that the client is obligated to provide payment for the transaction
  • Ensuring that the seller can get paid for the products or services rendered
  • Detailing the terms and conditions of the deal, as well as payment methods
  • Offering a way for both parties to keep time-stamped records of the transaction

A sales invoice is sent by the seller to the client before the actual payment occurs, but it’s also possible for a buyer to send a similar document to a vendor, which is known as the purchase invoice. In these arrangements, the accounts receivable department of the seller handles the invoice, while accounts payable does so on the buyer’s side.

While seemingly a simple concept, invoicing is often a point of friction in modern business operations, especially when it comes to optimizing it with technologies and software.

Templates, for instance, can accelerate the writing and distribution of invoices. And most companies miss out on proper record keeping and business intelligence if they don’t collect and analyze data regarding their invoices.

What Are Invoices For?

Upon first inspection, invoices sound like a non-necessity. After all, why not just finish the transaction, collect the payment, and leave it at that? Invoices actually play several important roles in the accounting department:

  • Record keeping: Invoices help businesses track all their transactions, whether they’re buying or selling. Information like money spent, the nature of the goods or services, and the relationship with the third-party is recorded in an invoice.
  • Requesting payments: Accounting teams have a way to keep track of and request payments from buyers.
  • Legal purposes: In addition to recording revenue for tax purposes, an invoice can be used as proof of an agreement between the buyer and seller. Either side can use the document as protection against accusations of fraud.
  • Inventory management: Sellers can track their inventory levels and predict future sales given previous sales activity. The result is an easier time managing stock.
  • Business analytics: Invoicing documents naturally play a role in accounting strategy, as you have records of all your purchasing activities, the buying patterns of your clients, and your most popular products.

Invoices are an invaluable tool not only for accountants but also business strategists and marketing teams, hence why invoice management is such an emphasized point in today’s organizations.

Why Does Invoicing Matter?

An optimized invoicing process helps you stay organized and ensure you’re receiving payments. Additionally, if communication with your buyers is smooth and seamless, first-time customers are more likely to become recurring ones. You can also avoid any customer frustration resulting from slow invoice fulfillment.

On the seller’s side, invoicing helps keep track of cash flow by detailing what payments are set to be made by which customers at what times. Should there be any outstanding balances, invoices will keep tabs on them.

A stronger invoicing system helps promote better cash flow management to ensure that you aren’t out of money when you need it most. And finally, the IRS occasionally audits businesses and asks for detailed financial records, which invoices conveniently provide.

How Do Invoices Fit Into the Context of B2B Sales Processes?

The general life cycle of the invoice is a lot more involved than you might initially think. It begins once a customer purchases a product or service from you and ends once you receive payment, but there are plenty of intermediate steps to keep track of.

  • Upon initial sale, you agree to provide the goods or services requested by the client business. You generate an invoice, possibly from a pre-prepared template, and send it to the customer.
  • If the client pays, you receive the money, match the transaction to the right invoice, verify the invoice as paid, and send out a receipt.
  • If the client fails to pay on time, chase after the payment and possibly charge a late fee or use legal action to enforce your agreement.
  • At the end of the financial period, report the income to the government for tax reasons and use your invoice data to record information on your previous sales. This data can be used to make more informed business decisions later.

Proper invoice management plays a strong role in how organized this process is, and we’ll discuss later how automation and digital management boost the efficiency of invoicing.

Invoicing in the Context of Other Business Functions

Invoicing directly helps out the accounts payable department of the seller business. Invoice documents track product sales, which helps with inventory control and accounting tasks. Payments for invoiced transactions often come several days after the sale, so managing cash flow demands the use of invoices.

Invoicing is also an area where internal financial controls can exercise their powers. Invoices must go through an approval workflow to be accepted, and financial auditors will use invoices as a reference to determine where cash went during the financial period.

What Are Some Types of Invoices?

Since there are many types of transactions, there are a variety of different invoices to use depending on the situation.

  • Commercial: For sales between international parties, a commercial invoice is used for customs declaration.
  • Credit: A buyer submits a credit note if the purchase needs to be refunded for any reason.
  • Debit: Sometimes, the scope of the project increases or more work needs to be done than previously expected. The seller issues a debit invoice to reflect the increase in amount owed.
  • Interim: Interim invoices are made while delivery of the service is in-progress. The buyer pays for portions of the work at a time, and a final invoice is sent at the end to detail all of the invoices together.
  • Past-due: Invoices are also sent whenever a buyer fails to make a payment on time as per the terms and conditions of the transaction.
  • Pro forma: A seller’s invoice to commit to delivering the goods and services for an agreed-upon price.
  • Proposal: Also known as a bid, proposals are for long-term services or larger projects. The seller estimates how much the final cost will be and suggests it to the buyer. This estimate is not the same as the final official charge.
  • Recurring: Customers purchasing subscription-based products or services receive recurring invoices for each charge.
  • Retainer: A buyer choosing to make an advance payment can submit a retainer invoice to have the amount deducted from the final payment.
  • Timesheet: Sometimes, invoices regard the sale of services charged on an hourly basis. Sellers submit a timesheet invoice for this purpose.
  • VAT: VAT-registered companies might issue these invoices to cover VAT charges on sales or reclaim VAT on purchased goods.

The choice of which one to use, from a pro forma invoice to a recurring invoice, comes down to your accounting department and can depend on the nature of the purchase as well as whether it’s a product or service.

Knowing what an invoice is matters, but those working in accounting must also know what an invoice isn’t. It’s important not to confuse invoices for other types of documents that a finance department might also run into.

Bills

Bills can be thought of as more general invoices. The details included in a bill are less specific and might not contain the same type of data as an invoice would, such as identifying information about the customer.

Both bills and invoices are sent by the seller after a sale is made but before the payment goes through. The key distinction, however, is that bills typically require buyers to pay immediately, whereas an invoice usually involves the seller asking for payment at a later time.

Contracts

While invoices can clear up the terms and conditions of the deal and be used as legal proof of the transaction, they are not legally enforceable by themselves. Businesses usually write contracts to go with the invoices to make them legally binding and require customers to agree to them. Contracts when used alongside invoices help prevent potential legal disputes later.

Quotations

For products and services where the price tag isn’t set in stone from the beginning, a customer might request a quotation from a vendor to estimate the cost.

Quotations are merely a way to convey information. The buyer is not obligated to purchase anything yet, and the seller typically provides more general details in such a document.

Purchase Orders

Customers write down what they want to buy from a seller on a purchase order. The key distinction between this document and an invoice is that a purchase order is created before the transaction, whereas an invoice comes afterward.

Businesses often use purchase orders as part of the approval workflow, and some of them require purchase orders only for particularly large transactions.

Receipts

Receipts are issued from the seller to the buyer indicating that the payment has been received for a specific transaction. The seller can keep this document as proof of purchase.

Invoices and receipts share a lot of common information, but the subtle distinction is worth noting. Receipts are kept only by the buyer to indicate that payment has been made and that the goods or services have been received.

What’s the Best Way To Conduct Invoicing?

Invoicing might sound like a purely empirical task, but getting invoices done efficiently is actually a lot less formulaic than it seems. These tips and best practices will help you get the most out of your invoicing solution and ensure that you get timely payments while still fostering positive relationships with your clients.

Timing and Frequency

You want to write up and send out invoices as soon as possible so that the transaction is fresh in your mind and you can include all the necessary details immediately, such as the name of the client, the amount due, and the timeframe for delivery.

Sending out an invoice early also helps your client pay you faster, as the payment process cannot begin until the client receives your invoice. It’s recommended that you take advantage of templates and electronic invoice management tools to speed up the process.

In terms of frequency, some companies send out individual invoices for every transaction, while others choose to send one large one out at the end of the month to cover all outstanding balances. If this latter strategy suits you, you must indicate so on the invoice and show that no other invoices will be sent for that month.

Two metrics to track in this regard are Days Sales Outstanding (DSO) and the accounts receivable turnover ratio. DSO is the average number of days it takes for your company to collect payments after a sale has been made. The accounts receivable turnover ratio measures the productivity of your accounts receivable department, which directly impacts how efficiently you can collect revenue from sales.

Prompt Payments

An effective invoicing strategy means fast payments that boost cash flow while still allowing your clients some “breathing room” to provide payments. Thanks to the rise of online communication and commerce, paying back an invoice shouldn’t take more than a couple weeks. In the past, most vendors had to expect around 30 days of lead time.

To incentivize on-time or even early payments, consider tactics like:

  • Offering discounts for early reimbursement
  • Asking for shorter payment terms in the contract
  • Negotiating timeframes when it comes to larger transactions
  • Sending out reminders automatically through invoicing software
  • Demanding payment in the event of a past-due invoice

Take time to discuss your expected timelines upfront so that client expectations are set early on and there’s no confusion later. Make your expectations clear in the invoice.

And when it comes to deciding on overdue fees, keep in mind that charging for overdue invoices is common practice. Charge just enough to incentivize the client to pay on-time, and make your policy clear in the invoice. Also consult your local laws, which might dictate limits to how much you can charge on late fees.

Settling Disputes

In some instances, clients may disagree with the issued invoice in some way and might refuse to pay until the dispute is resolved. Be prepared to conduct communication with the client to find out what problematic areas of the invoice need discussing.

In rare cases, an unpaid invoice may need to escalate to legal action, and the vendor potentially needs to write off the unpaid invoice as a debt.

Don’t be afraid to hold off on selling more products or services to a client if it fails to cover for a previous invoice. Statistics have shown that over half of businesses expect late payments nowadays, though only 10% of invoices end up not paid at all.

Paper vs. Digital

Traditional invoicing involved paper copies that had to be copied multiple times so that both parties could reference the documents. Today, we’re seeing widespread adoption of computer-generated online invoices. Electronic copies are faster to share and easier to search and sort through. It’s also possible for automation to accelerate the process even further.

Remember that streamlining invoicing is also a component of building up the customer experience. If you make invoices easy to work with for your customers, you are encouraging them to choose you again in the future.

The Contents of a Typical Invoice

Professional invoices must include plenty of information to clear up the details of the transaction and your contractual agreement with the client. Make your invoice clean and readable while still providing all the necessary details.

What are the components of a typical invoice? First off, start your invoice templates with some indication that the document is an invoice so that it can be quickly identified. Beyond that, look to include the following parts.

The Identification Code

Invoices come with ID numbers, unique alphanumeric codes specific to individual invoice documents. These codes, also known as reference numbers, are crucial for identifying transactions with clients. You generate an invoice number according to your own numbering scheme. There are many ways to organize invoice IDs:

  • Sequential numbering (e.g. 0001, 0002, 0003, etc.)
  • By date (e.g. 2022-12-01-014 for the 14th invoice on December 1st, 2022)
  • By client (e.g. 047-004 for the 4th invoice given to customer #047)
  • By project (e.g. 375-012 for the 12th invoice written for project #375)

While you don’t necessarily have to follow a strict order, a consistent scheme of identifiers helps prevent confusion and stops you from assigning the same invoice ID twice by accident. These codes are used both internally and externally, so it’s important to assign invoice numbers consistently.

Dates

Invoices must be time-stamped with the dates on which the goods were billed and the transaction was officially recorded. Don’t forget to time-stamp whenever the invoice itself was sent out. Dates are essential if you’re offering credit to your clients, who can then determine the due date of the bill and the duration of the credit.

Dates are also used to track return policies, as customers can reference how many days since the proof of purchase it’s been.

Order Descriptions

Whether we’re talking about products or services, you want to describe the activities the vendor provided or the product ID or SKU involved in the transaction. Invoices typically provide an itemized list for this purpose.

It’s also worth asking the client business about an invoice’s analogous purchase order number to include in the invoice as well.

Contact Information

Include the legal name of the client business (which might be different from the trading name you’re familiar with) and any necessary contact information. Do so for your organization as well so that both the seller and buyer can communicate with one another in the event of an error or mistake.

On the same note, remember to send the invoice directly to the accounts payable department of the client business. Don’t just forward it back to whoever placed the order, who might not be responsible for handling incoming invoices.

Payment Terms and Conditions

Include all the terms and conditions of the business transaction on the invoice, such as:

  • Accepted payment methods
  • Due dates for delivery and payment
  • Currencies used in the transaction
  • Policies for late payments

Payment terms need to be specific but also flexible. For instance, a vendor might only collect a portion of the payment upfront and ask for the rest at a later date. It’s worth knowing some of the common payment terms invoices use in these instances:

  • Cash in advance (CIA): Payment must be made in cash fully before services are delivered.
  • Cash on delivery (COD): Payment is due only once the products are successfully delivered.
  • End of month (EOM): Payment must be made by the end of the specified month on the invoice.
  • Month following invoice (MFI): “X MFI” means that the payment due date is on the Xth day of the month after the invoice date.
  • Net: “Net X” means you need payment X days after the invoice date. “A/B Net C” means that payment is due within C days of the invoice date. However, an early payment within B days results in an A% discount.
  • Payment in advance (PIA): Payment must be made fully before services are delivered (though not necessarily in cash).
  • Upon receipt: Clients don’t have to start payment until the invoice is received.
  • % upfront: Customers must pay a percentage of the full invoice before the product or service can be delivered. Upfront payments are common for larger projects.

Enforcing due dates and late penalties are a common way to encourage buyers to pay on-time. This portion of the invoice is an opportunity to boost your cash flow and receive payments sooner, and being clear in your payment terms elucidates any misunderstandings between the parties.

Total Charges

Of course, an invoice must have the price listed prominently. Include the cost of each unit of product; the quantities ordered; and any charges related to shipping, handling, and sales tax. Deduct any discounts or early payment promotions, and add in charges for late payments if applicable.

At the end of it all, include a total amount owed prominently at the bottom of the invoice after all the modifications, discounts, and extra charges have been added up.

A Thank-You

While professional invoices are considered formal documents, it’s not uncommon to see personalized thank-you notes. Phrases like “Pleasure doing business with you!” can be added near the end.

Industry-Specific Information

Invoice templates may vary from business to business and change according to your unique needs or the standards of your industry. A hospital, for example, might want to include procedure codes that can be used for insurance purposes.

It’s worth keeping in mind that invoice templates are not standardized. While most should include the same elements, modifying your invoice template to match your needs is still recommended.

Beware of Invoice Fraud

In the field of corporate accounting, the potential for fraud can never be entirely ruled out. Invoice fraud occurs whenever a criminal pretends to be a genuine supplier and asks a client business for “payment” for services or products that were never delivered. In some cases, it tells the client that the transaction terms have changed and that a new payment will be required for a separate account.

Financial losses due to invoice fraud have increased in recent years, partly thanks to digitization and increased financial activity from businesses of all sizes. A study by Abnormal Security predicts that invoice fraud will likely increase significantly from 2020 to 2021 and beyond.

Fraudulent invoices can occur in several ways:

  • Inflated charges: In this case, a fraudster sends a fake invoice with an inflated charge, which is just small enough not to arouse suspicion.
  • Missing deliveries: Some fake invoices are submitted for products and services that were never actually delivered in the first place. Fraudsters rely on using vendor names that a victim is familiar with to minimize the chance of the victim finding out.
  • Duplicates: Submitting duplicate invoices is another way to masquerade a fake invoice for a real one. Having a proper invoice ID numbering scheme is one of the best defenses against this attack.

Invoice fraud can happen to anyone, but it’s especially prevalent for businesses with poor invoice management systems and policies. When you work with hundreds or even thousands of invoices every month, a fraudulent one seeping through the cracks isn’t too hard to imagine.

Getting your invoice management solution done right is the best way to fight against invoice fraud schemes that even the most experienced Accounts Payable teams occasionally fall for. You need the right visibility and invoice monitoring tools to do so.

For instance, companies need to review their purchase orders and invoice history thoroughly. Automated invoice scanning and matching tools help in this regard. You can also check the format of the invoice to notice mistakes, poor grammar, or other red flags that point to a fake invoice. And finally, make sure all invoices are accounted for in the sense that you can match delivered goods and services with an invoice.

What About E-Invoicing?

Electronic invoicing solutions have plenty of advantages for companies struggling with inefficient invoicing or defending against fraud. It’s important to see online invoices as an evolution of traditional invoicing solutions.

How Has Invoicing Improved Over Time?

Managing invoices has been an essential business process since businesses existed. In fact, archeologists have found stone documents dating back to 5000 BC in Mesopotamia that likely kept track of large transactions.

Most invoicing solutions we’re familiar with are paper-based, but newer companies are starting to pick up electronic invoice documents made in modern word processors or spreadsheet programs. Electronic invoices are more efficient, require less manual work to create, and can be stored more cheaply and reliably.

Today, we’re seeing the advent of a new form of invoicing powered by the Internet and mobile devices. Paperless invoices can now be sent online. Combined with online payment methods, online invoices can be generated extremely quickly and processed almost instantaneously. Accounting software can run even on mobile devices, enabling staff to work with invoices on the move.

How Does Going Digital Help with Invoice Processing?

By digitizing invoice processing, you automate many of the tedious, manual labor-focused tasks that are slowing down your financial management efforts and increasing the amount of time necessary to get paid. Invoice processing involves several steps that automation and digitization can help with:

  • Document matching: It’s always best practice to match a buyer’s purchase order or receipt with the seller’s invoice to verify transactions and ensure correct payments. Document matching is much easier on a digital platform when you can easily scan and search all the necessary data.
  • Approval workflows: Authorized entities in the business must approve or reject invoices to ensure that their transactions line up with company goals and policies.
  • Internal controls: Having a single invoicing dashboard centralizes all the internal controls the accounting team needs. Not only are all your data and processes together in one place for easy use, but most e-invoicing platforms integrate well with other tools like purchase order management. The result is a single, streamlined workflow with everything you need.
  • Fulfilling payment: Electronic invoices can be quickly submitted and authorized in a corporate financial system so that payments are processed faster. Whether it’s by check, wire transfer, or any other method, you can expect invoices to be paid faster with the preferred payment method.
  • Archiving invoices: The IRS has actually advised businesses to keep records of their transactions, and digital invoices are easier to save and store securely. Instead of stacks of papers and filing cabinets, digital document storage is efficient and inexpensive, which is perfect for auditing purposes. 
  • Tracking performance: Going digital also means an automatic way to establish and track key performance indicators—such as the average amount of time it takes to pay or approve an invoice, the total cost of invoice processing, or the incidence of late invoice payments. Knowing these metrics will help you improve the way your business processes invoices.

Depending on the feature set of the e-invoicing service you choose, some platforms can even automatically capture and extract data from paper invoices and PDFs through optical character recognition (OCR) technology.

What Are the Benefits of Invoicing Software?

The application of software to improve traditional business practices has been seen throughout the past few years, and it’s where the term “digital transformation” has come from.

Invoicing, being a financial process that relies on rule-based approval workflows and quantitative data analytics, is a prime target for software-based optimization. Some of the advantages of e-invoicing solutions include:

  • Quickly generating new invoices: Instead of starting from scratch, you can create and draw from templates to speed up the process and make modifications as needed. The faster you send out the invoice, the faster you can get paid. Templates also ensure that you aren’t missing important parts of the invoice before you send one out.
  • Automated approval flows: Instead of tediously asking all the stakeholders to approve a transaction, e-invoicing software can notify the right people immediately and get the job done quickly.
  • Cybersecurity features: One valid criticism of the digital transformation is the increased risk of cybersecurity attacks. However, e-invoicing platforms have been working on digital security features specifically designed to prevent those attacks.
  • Integrations with other tools: When invoicing can work cohesively with, say, customer relationship management portals and other financial tools, your overall workflow becomes more streamlined and productive.

E-invoicing results in more efficient and secure invoicing procedures, making the job of accounts payable and receivable departments easier. And, of course, most financial management platforms that specialize in e-invoicing also tend to offer support for other related tasks like receipts, purchase orders, vendor onboarding, and others.

Simplify Your Invoicing Processes with Tipalti Approve

Invoices play a significant role in managing complicated B2B transactions. Getting them processed correctly means a better customer experience for your clients and faster payment for you. With the right AP or e-invoicing tools, you can even make your accounting teams more productive and help collect important metrics and analytics from your invoice record books.

In today’s competitive market, a business needs an automated AP process for faster and simpler invoicing and payment processing. Explore Tipalti Approve’s solutions if you want to eliminate manual work and bring your processes into the future. 

Interested in implementing a spend management system that simplifies and streamlines your business’s existing process? Check out Approve.com and request a free demo today!

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