Energy regulator Ofgem has demanded that energy providers take action to give consumers a fairer deal or face regulatory action.
The watchdog's report comes after consumer body energywatch complained that gas and electricity suppliers were "back-billing" customers when they made mistakes.
Back-billing is when suppliers who have failed to send out gas or electricity bills for some time require the homeowner to pay for the entire period at once.
The regulator said that while most of the time suppliers billed customers fairly, in a number of cases customers suffered "real harm" when suppliers made mistakes.
"For the vast majority of customers, the energy market works well. But suppliers can get things wrong and when they do, this can cause customers real distress and hardship," said Ofgem chief executive Alistair Buchanan.
He added: "We have ... told the industry that they have a year to put their own house in order - or risk facing regulatory action."
Ofgem said gas and electricity suppliers had to deliver "three key steps" to satisfy it, the first of which was to stop back-billing customers beyond two years if the company was at fault. This will reduce to one year in 2007.
Secondly, suppliers must set up an independent body with the power to award compensation to resolve disputes quickly, while they must also review their domestic customers' contract terms to ensure compliance with consumer rights legislation.
Energywatch chief executive Allan Asher welcomed the regulator's ruling, saying: "A win-win situation for consumers and companies is within sight if companies can make billing both timely and accurate. Consumers get a better service and companies get to recover their payments."
Duncan Sedgwick, chief executive of the Energy Retail Association, which represents all the major energy suppliers, added: "The industry has been listening to what its customers want and will look carefully at Ofgem's recommendations.
"Consumers want ever more accurate bills and the energy industry is developing a range of measures to make this happen."