Invoice Classification Made Easy: Tips, Types & Best Practices

Invoice classification is the process of organizing these documents for easy tracking, access, and retrieval. This helps professionals and businesses to maintain the accuracy of their accounting efforts, follow the tax laws adequately, ensure payroll transparency, and support compliance with the IRS and other government recordkeeping requirements.

In this article, we’ll explore different types of invoices and various methods of classifying them. We’ll also show you the benefits of invoice classification, the tools you can use, and the best practices to help you master recordkeeping.

What Is Invoice Classification?

Invoice classification is the practice of grouping invoices into distinct categories based on shared characteristics. These characteristics depend on the reason for classifying invoices, and these can include the type of invoices, their purpose, and payment terms.

Putting every invoice into a single folder is a bad practice that can result in a lot of time and manual work required to browse through them when you need to find something specific. For instance, it can lead to complications during audits or result in missed payments due to a lack of sent payment reminders for invoices.

Optimal invoice organization becomes important as soon as the volume of these documents increases. It ensures proper bookkeeping and accurate financial reporting, both of which help you avoid making potentially costly mistakes. It also speeds up audits and financial reviews and allows you to go back to regular operations faster and more efficiently.

For instance, if you’re ever asked during an audit to provide documentation for a transaction from prior years, you need to be able to find a relevant invoice and associated information. A proper system with adequate invoice classification lets you do that in seconds.

10 Different Types of Invoices

There are many different types of invoices, each serving a distinct purpose. Here are some of the most common ones, frequently used by businesses and professionals:

1. Standard invoice. A standard invoice is the most common, and it’s used to request payments for goods sold or services provided.
   
   
2. Pro forma invoice. This is an invoice sent before the work begins or the goods are shipped. It’s used to estimate the final cost. As such, these invoices have no legal bearing and are mainly used to establish transparency with customers.
   
   
3. Recurring invoice. A recurring invoice is sent repeatedly, at regular intervals. It’s used for ongoing services, like retainers and subscriptions.
   
   
4. Commercial invoice. This type of invoice is used in international trading. It is used as a customs declaration for international shipping to describe the goods and their value.
   
   
5. Past due invoice. A past-due invoice is sent when a standard invoice hasn’t been paid on time. It’s typically marked with a “Past Due” stamp, and may include late fees in addition to the total amount due on the regular invoice.
   
   
6. Timesheet invoice. This document is typically used by freelancers and contractors who bill their clients based on the hours worked.
   
   
7. Interim invoice. An interim invoice is a partial bill sent to the client after a milestone has been reached on a bigger project.
   
   
8. Final invoice. This is the final invoice sent after the completion of a large-scale project. It’s a request for the remaining amount owed after all the interim invoices have been paid.
   
   
9. Debit invoice (debit memo). This document is issued to increase the amount owed on the original invoice due to initial under-billing or additional charges.
   
   
10. Credit invoice (credit memo). The opposite of a debit invoice, this document reduces the amount due in the original invoice.

How to Classify Your Invoices: 6 Methods

There are many ways to classify your invoices, with no one method being “right” for every situation. Accounting for small businesses and contractors needs to be flexible, so the best method will depend on your needs and circumstances. Let’s see what the most common ones are.

#1. By Client

Invoice classification by client is one of the most straightforward methods typically used by freelancers and agencies that work with lots of clients. An easy way to do this is to create a folder for each client and use it to group invoices. You can also create a tag in your bookkeeping software for a client that you frequently invoice, to make everything more organized.

This classification method also allows your accounts receivable aging reports to identify outstanding balances and slow-paying clients more easily. Then, you can adjust your invoicing strategy or proactively follow up with them to improve payment frequency and optimize your cash flow.

#2. By Payment Terms

Invoice classification by payment terms is good for managing and improving your cash flow. Typical payment terms include “Due on Receipt” and net terms (e.g., net 30, net 60).

By using this method, you can sort and filter through your invoices based on when you expect payment. This allows you to promptly send reminders when needed and reduce overall instances of late payments.

This is a good classification method to combine with automated reminders. It can help you significantly reduce your days sales outstanding (DSO), increase your financial predictability, and enhance forecasting accuracy.

#3. By Invoice Status

Classifying invoices by status groups them based on the stage to which they have progressed. Common statuses include draft, sent, partially paid, paid, overdue, disputed, cancelled, and void.

This is a great method that allows for easy tracking of unpaid invoices. When you classify invoices by their status, you can effortlessly find those that are partially paid or overdue, before sending reminders to the clients. On the other hand, keeping an eye on drafts reduces the risk of forgetting to bill clients on time.

You can also use status categories to generate accurate aging reports. This information is useful when performing revenue analysis or when managing customer relationships.

#4. By Project or Department

If your client is a large organization or if you’re contacted for large-scale endeavors, you may work on multiple smaller projects. Alternatively, if you’re running a large business and providing multiple services, you can classify invoices by different departments.

For example, you can have multiple invoices classified by project and marked as “Website Redesign.” Or, you can classify an invoice as “Marketing” or “Operations” if sent by those teams.

This approach gives you a detailed insight into your profitability. You can look at different invoices billed to the same client and assess whether some projects are over budget. Classification by department can tell you if a certain part of your team is underutilized or if they spend too much on contractors.

#5. By Type or Purpose

If you’re consistently sending different types of invoices, you can separate them to make financial reporting during the tax season more accurate. For instance, separating invoices by type or purpose (e.g., goods, services, reimbursements, etc.) ensures you can properly categorize deductible expenses to reduce your final tax bill.

#6. By Fiscal Year

Classifying your invoices by fiscal year is essential for tax filing purposes. This allows you to use the correct documentation when determining your income and expenses. Plus, the IRS requires you to keep financial records for up to 7 years. When you organize invoices by fiscal year, you will avoid accidentally deleting documents that are still relevant.

Benefits of Proper Invoice Classification

There are many benefits to proper invoice classification. Taking the time to implement one or more methods can significantly improve your operations and even result in financial gains.

Here are some of the biggest advantages of invoice classification:

• Improved cash flow. Optimal invoice classification can directly influence your cash flow by helping you spot overdue payments more easily. This allows you to send reminders and follow-ups more consistently, reducing your days sales outstanding (DSO).
  
  
• Audit preparedness. IRS audits can turn into challenging endeavors if you don’t keep meticulous track of your invoices and other financial documentation. What can be a simple administrative task can take hours of your time and even escalate into bigger problems if you can’t find the invoices that you need to.
  
  
• Better budgeting. With optimal payment tracking and clear insight into the upcoming revenue, you’ll have more data to use when making financial forecasts. This will allow you to plan for future spending and allocate funds in advance with more precision, enabling data-driven decision-making.
  
  
• More efficient workflow. Invoice classification is the first step in the automation process. When you separate invoices into distinct groups, you can tag them and use software to automate activities like payment reminders and reconciliation.
  
  
• Reduced risk of errors. When you properly classify invoices, you can easily spot if you have duplicate entries or if you’ve issued incorrect charges. That way, you can prevent these instances from happening or quickly correct them if they do.
  
  
• Enhanced professional image. Quickly responding to client inquiries regarding specific invoices demonstrates proper organization on your end and projects a professional image. Having your invoices classified allows you to do that in seconds, ensuring you can respond to questions about documents from months or even years ago.

Tools & Best Practices For Invoice Classification

Tools and best practices for invoice classification don’t have to include expensive software and meticulous workflows. While large corporations often use costly ERP systems, invoice management for small businesses and freelancers typically requires small-scale, more agile solutions.

One of the most important tools you can use is a dedicated invoice generator. At Paystub.org, we developed robust software that allows you to quickly create professional and accurate invoices. The generator enables structured invoice numbering and dating, allowing for effortless future classification and management.

Alternatively, you can use digital invoice templates, like Word invoice templates or Excel templates. Though keep in mind that it takes more time to create an invoice with a generic template, and there’s more room for error.

The professional and uniform invoices you get by using the generator make it easy to classify them further. Here are some of the best practices and freelancer invoicing tips to help you achieve that:

• Give your invoices standardized file names, like “YYYY-MM-DD_ClientName_InvoiceNumber.” You should store them in organized folders, and name and sort the folders using a determined method (e.g., by type, client, or month).
  
  
• Digitize all associated documentation. Scan any physical receipts or paper invoices that you don’t have in a digital format and classify them based on the methods you use. The IRS accepts digital documents in file formats like JPG and PDF.
  
  
• Regularly conduct internal audits and reconciliations (e.g., on a weekly or monthly basis) to review your records. Verify if you changed the statuses of invoices to ensure they are up to date (e.g., to ensure that “Unpaid” invoices haven’t actually been paid and you just forgot to update their status).

Final Thoughts

As you can see, invoice classification is a straightforward but invaluable aspect of running a business. Once you understand the essentials, implementing even one or two of the most basic classification methods can significantly improve your recordkeeping, help with your audit readiness, improve your cash flow, and contribute to your budgeting and forecasting.

Bookkeeping for freelancers doesn’t have to be complicated, as all you need is a good document generator, a classification system that suits your needs, and a method for tracking invoices. This will result in far fewer errors, less time spent on administrative work, and more predictable outcomes with regularly paid invoices.

Invoice Classification FAQ

#1. Can freelancers classify invoices efficiently without software?

Yes, freelancers can classify invoices efficiently without specialized software by using simple spreadsheets. They can use Google Sheets or Microsoft Excel to input details like invoice numbers, dates, statuses, and clients. This can be paired with a robust folder structure to make storing and retrieving invoices straightforward.

#2. What is the easiest way to track invoice status?

The easiest way to track invoice status is to use specialized software that does it automatically. If you’re classifying invoices manually (e.g., by using a spreadsheet), you can implement the “traffic light” system, where you use color green for paid, yellow for sent, and red for overdue invoices.

#3. Why is invoice classification important for tax filing?

Invoice classification is important for tax filing, as it helps you accurately report income and claim all eligible deductions. Misclassifying expenses or incorrectly reporting your earnings due to disorganized invoices can result in penalties or an audit by the IRS.

#4. How long should I keep invoices?

You should keep invoices for at least 3–7 years. The IRS has clear regulations regarding which documents you need to keep for how long. In addition to that, you should check out your state’s laws and regulations for any additional requirements.