At the inception of any small business, there’s the expectation that an open invoice will be a regular part of a business’s life cycle.
After all, once business graduates from the status of cash-only (if it ever started as one), it immediately transitions into creating invoices for your services provided or products sold.
The core idea behind invoices is granting your customers the leeway to pay you back later. However, how do you identify that period between issuing an invoice and receiving the payment? Welcome to the word of open invoices.
Read on for an in-depth look at what an open invoice entails, and how a business deals with one from an accounting perspective. In addition, we’ll explore the different types of open invoices you’ll undoubtedly stumble upon during your business’s life cycle.
What Is an Open Invoice?
In the simplest of terms, an open invoice is an existing invoice that has not yet been paid in full.
It’s considered an umbrella term that can span numerous types of invoices. For instance, if you have a pending online payment in your billing/revenue section, that would be considered an open invoice.
In addition, an open invoice is “closed” once it’s been paid by a customer and moved to your revenue section. Afterward, when a payment is transferred to your business’ bank account, that ex-open invoice will be under your payments section.
This can include payments that the customer still hasn’t added a payment method, a payment that’s pending with your online payment processor, an online payment that’s waiting to be confirmed, or even charges that have been declined or failed.
How Does an Open Invoice Work?
Now that you have a solid understanding of what open invoices actually are, it’s time to tie them into your regular business accounting and bookkeeping processes.
Once an open invoice has been created, both the customer and the merchant (that would be your business) will have a specific account for that open invoice on your balance sheets.
If you’re the business providing the service or product then you’ll see that open invoice as an asset. It’s funds that can be adequately relied on for paying upcoming business liabilities, like purchasing raw materials and making lease payments.
On the other hand, an open invoice will be seen as a current liability for the customer. It’ll show up on the side of liabilities, opposite the customer’s cash reserves, cash flow, and accounts receivable.
For both the merchant and the customer, the open invoice will stay in their previously selected spots on your accounts until the invoice is closed.
The Transition From an Open Invoice to a Closed Invoice
An open invoice seizes to be one when the customer makes a payment, and the merchant receives the payment in full. It then becomes a closed invoice. The transitional process occurs on both the customer and the merchant’s accounts.
For the customer’s account, the payment will be posted as a credit to the accounts payable account. Generally, it’ll include all the details relating to the invoice, like it’s invoice number and the supplier’s information.
This way businesses can be prepared if they are audited, as well as making it easier to track everything if there’s a problem with the invoice payment for any reason. On the merchant’s end of the spectrum, it’s the reverse. The invoice’s payment will be added as a credit memo in the accounts receivable section.
Same as with the customer’s account, all the invoice’s details will be added to the transaction, like the invoice number, as well as the customer’s check number. Finally, with the payment being in full and matching the correct amount as stated on the invoice, the invoice can now be closed.
Types of Open Invoices
When we look at open invoices, there tend to be four main types that your accounting department deals with on a regular basis.
1. Pending Online Payments
Pending online payments are open invoices that are initiated by a payment processor. However, these payments haven’t been confirmed, yet. For instance, it could be that the sales amount hasn’t left the customer’s bank account.
These invoices will be placed in the “Pending Online Payments” category until they’ve been paid off. Moreover, these payments are confirmed (or declined) automatically by the payment processor. Therefore, you don’t need to take any sort of action at this point.
2. Pending Offline Payments
This type of open invoice is rather similar to its predecessor. The payment will be pending in an offline processor, like cash payments or even bank transfers that tend to take a bit longer to conclude.
Yet, unlike pending online payments, you’ll have to manually confirm the payment status on these transactions.
Bills are open invoices that must be paid by the customer, yet it has failed in one form or another. When a payment fails, it will automatically be “retired” by the system.
This means that you’ll have an existing bill for the invoice until a successful payment has occurred. Essentially, a retired payment will drop into bills automatically, even if there was only a system glitch that stopped the payment from finalizing.
In addition, these types of open invoices will need extra attention from the merchant, as they’ve already shown signs that there might be issues with payment.
4. Failed Payments
If bills need extra attention, then failed payments need a whole department on the outlook for their status. A failed payment is one that “failed” and is now being retried.
As it were, payments can fail for a multitude of reasons. These can range from insufficient funds in the customer’s account, or their card has been declined. The transition from bills into a failed payment happens when the payment hits its auto-retry limit.
Of course, these types of open invoices will need certain actions taken from the merchant to ensure its successful transition from an open invoice to a closed one.
Managing Open Invoices for Businesses
When you’re starting a small business, the mere idea that you might not be paid for your services or products can be mindboggling, as well as anxiety-inducing. However, learning how to recognize an open invoice, in addition to correctly recording it, can help immensely with getting your payments back and on time.
Now, you know all about open invoices, how they work, and their numerous types. Yet, there is still a plethora of business terminologies and concepts that you need to learn. For example, how familiar are you with invoice factoring?
If your business is on the lookout for a loan, apply today by filling out our simple application.