What is a chargeback in accounting?
Whether you're a seasoned business owner or just starting out, chargebacks can throw a wrench in your accounting — and your cash flow. Read on to learn what they are, why they matter, and how to handle them effectively.
What is a chargeback?
A chargeback happens when a customer disputes a charge with their credit card company and gets their money back even after they've made a purchase from your business. It’s a financial tug-of-war: you've provided goods or services, but now the customer wants their money back through their credit card company instead of working directly with you.
What makes chargebacks especially tricky is timing. You might not know about a dispute until weeks after the sale, and by then, you've likely already recorded the revenue and possibly paid expenses related to that transaction. This delay can make your books messy if you're not prepared.
Further, each credit card company handles chargebacks differently, which adds another layer of complexity. To effectively handle chargebacks, you need to be sure to comply with each card’s specific rules.
Why do chargebacks matter?
Beyond the immediate hit to your cash flow, chargebacks can have serious ripple effects:
You might get hit with higher processing fees from your credit card company if you get too many disputes.
You could lose your merchant account if your chargeback ratio gets too high.
Time spent gathering documentation and fighting illegitimate claims takes away from time spent running your business.
If you don’t properly record chargebacks, you’ll face tax implications that can complicate your returns. For example, you might overstate your income and pay more taxes than necessary.
There could be an impact on financial statements that could affect business loans or investment opportunities.
What happens if you ignore chargebacks?
We've seen too many small businesses learn the perils of neglecting chargebacks the hard way. Ignoring chargebacks won't make them go away; it'll only make things worse. Banks typically give you 7-10 days to respond to a dispute. Miss that window, and you automatically lose the case.
In addition to the negative effects listed above, multiple losses can lead to:
Frozen merchant accounts
Placement on credit card networks' warning lists
Cash flow problems from unexpected reversals
Damaged relationships with payment processors
How to record chargebacks correctly
When a chargeback hits, you'll need to make several accounting entries:
Record the initial reversal as a reduction in revenue and accounts receivable.
Track any chargeback fees separately as a bank service charge expense.
If you lose the dispute, record it as bad debt expense. This helps track the true cost of chargebacks to your business.
Pro tip: Create a separate general ledger account for chargebacks to make tracking and reporting easier.
Common chargeback mistakes to avoid
Don't fall into these common traps:
Assuming all chargebacks are fraud when sometimes it's just customer confusion. Assuming the worst can lead you to respond too aggressively to disputes, damaging customer relationships and missing opportunities to improve your processes.
Waiting too long to respond to dispute notices. Missing response deadlines means automatic loss of the dispute and the revenue, plus you'll still get hit with the chargeback fee.
Not keeping detailed transaction records, including shipping confirmations, customer communications, and signed receipts. Without proper documentation, you'll lose most disputes even when you're in the right.
Missing the signs of friendly fraud, where legitimate customers dispute valid charges. Failing to spot patterns in these disputes makes it harder to prevent them and could result in unnecessary refunds.
Tools and systems for managing chargebacks
You don't have to handle chargebacks alone. Here's what can help:
Accounting software solutions
Accounting software like QuickBooks can help track chargebacks through custom accounts and generate reports showing their impact on your bottom line. This software will set up automated alerts for unusual transaction patterns that might signal potential chargebacks. It also includes built-in reporting tools to monitor chargeback trends and identify problem areas.
Other helpful tools
Chargeback prevention platforms that flag suspicious orders before they become problems
Documentation management systems to keep transaction records organized and easily accessible
Automated response systems that help you meet tight dispute deadlines
Clear return policies and customer service processes that can prevent disputes before they escalate to chargebacks
When in doubt you can always reach out to an experienced accountant to help you manage chargebacks.
Ready to get your chargebacks under control?
We're here to help you protect your business and keep your books accurate. If you need support with managing chargebacks and other financial challenges, explore the small business accounting services we provide.