How to account for unpaid invoices

If you run a small business, unfortunately it’s likely that at some point you’ll have an invoice that never gets paid. In this article, we explain what to do if you need to cancel or write off an unpaid invoice, and how you should handle this in your accounts.

Cancelling an unpaid invoice

If you’ve issued an invoice but haven’t provided the customer with your product or service yet, you might want to cancel the unpaid invoice with a credit note. 

A credit note is effectively a negative invoice and is a way of showing that the customer doesn’t have to pay the amount you’ve invoiced them for.

You might want to cancel an invoice with a credit note if you’ve invoiced a customer for a product or service that you haven’t yet delivered and you now know won’t be required. 

If you’re a FreeAgent user, you can create a credit note directly from the invoice in question. 

Writing off an unpaid invoice

So what if you provide a good or service and the customer simply doesn’t pay? After invoicing a client, issuing multiple reminders and making a few uncomfortable phone calls, you might finally decide to give up on chasing payments and write off an unpaid invoice as a ‘bad debt’. Before you do this though, we recommend you check out our guides on dealing with late-payment excuses and taking legal action when a client won’t pay. 

If you use FreeAgent, you can easily mark an unpaid invoice as written off within the software. Depending on which accounting method you use, you may then be able to claim tax relief on the written-off invoice.

If you use the invoice method for accounting (this is sometimes called the ‘traditional method’), you may be able to claim the cost of the written-off invoice back as an expense on your Self Assessment tax return. 

If you use the cash method for accounting then you can’t claim any tax relief on unpaid invoices, as businesses that use this method only pay tax on money they’ve received from customers. Even so, it’s still good practice to mark an invoice as written off for admin purposes if you don’t expect to receive payment for it.

If you're registered for VAT, writing off an invoice may also reduce the amount of VAT you have to pay to HMRC on your next VAT return. This is called 'bad debt relief'. 

Invoicing with FreeAgent

FreeAgent’s Invoice Timeline instantly shows the status of recent invoices and lets you see what’s been paid, what’s due and what’s overdue. You can even encourage late payers to pay promptly by using automated email reminders, and set up thank you emails for when those invoices are paid. 

Take a closer look at invoicing with FreeAgent and start your 30-day free trial today.