What Is a Proforma Invoice? Must-Know about Invoicing
In nearly every trade, buyers and sellers spend time negotiating the quantity of products to be supplied, price per unit, shipping details and whatnot. In between this back-and-forth, it is easy to misconstrue the final resolutions. To confirm the final details of this negotiation from the buyer before shipment, the seller has to issue a proforma invoice. This invoice outlines the final agreement and highlights possible additions like Value Added Tax (VAT).
Below, we’ll cover:
- What Is a Proforma Invoice?
- What Is the Purpose of a Proforma Invoice?
- What Is the Difference Between an Invoice, Proforma Invoice, a Quotation And a Purchase Order?
- What Should Be Covered in a Pro Forma Invoice?
- Can Payment Be Made on a Proforma Invoice?
- When to Use Proforma Invoices?
What Is a Proforma Invoice?
A proforma invoice or preliminary bill of sale is a legal document sent to the client before delivery to highlight the seller’s intent and commitment to selling at a particular price. It is also used to confirm from the buyers that they agree to what’s written on the pro forma invoice.
What is pro forma? In business climes, it is used to describe a planned transaction. Coined from the Latin word, Pro forma means “for the sake of form" or “as a matter of form”. A pro forma invoice streamlines the sales process by reducing or totally eliminating any back-and-forth when a transaction goes through.
Also known as a preforma invoice, it is designed to give a cost estimate of the sale and not the final cost. If so, it is subject to change. However, in an ideal setting, this change should not be a huge deviation from what’s written on the pro forma invoice.
In the case of international traders, a seller may request for an upfront or deposit payment before supplying the products to confirm the seriousness in trading of the buyer.
What Is the Purpose of a Proforma Invoice?
For the most part, a pro forma invoice is designed to streamline the sales process. Once issued by the seller, the customer is expected to agree to its contents before delivery is made. They are good faith estimates used by a seller to let the client/buyer know what to expect in the shipment.
The significance of a proforma invoice can be split into two folds:
a) For Shipping
In the case of shipping or import-export trades, it assists the seller/exporter to do the following:
- Obtain a bank line of credit to accommodate manufacturing costs or cost of purchasing the goods to be exported.
- In countries like the United States, it also comes in handy at the Customs office and can serve as an alternative for a commercial invoice. Without a proforma invoice generated by the buyer/importer, the Customs office may refuse to release the goods at entry.
Here are a couple of reasons why a proforma invoice is useful to the buyer
- It helps the importer/buyer obtain an import license where required.
- It may also assist in the collection of import and foreign exchange permits from the local government
- May assist in seeking finance from third parties for the project
- Help in fulfilling the country’s licensing procedures.
- They are mostly used in trade and export-import transactions.
(b) For customers
In this case, it is used to prove to the client or buyer that the seller is committed to honoring the order. For this usage, it can be likened to an estimate or quote.
What Is the Difference Between an Invoice, Proforma Invoice, a Quotation And a Purchase Order?
For instance, in the case of a purchase order, it is the buyer and not the seller who issues the document. Though they both share similar characteristics like containing product description, product quantity, prices and discounts, a purchase order is more legally binding than a proforma invoice.
Unlike a pro forma invoice, a purchase order is not subject to change. It is an official confirmation of sale from the seller while a proforma invoice is a preliminary bill of sale. The buyer (individual) or accounts payable department (company) sends the seller a purchase order for invoice matching when making payments.
There is also a profound difference between a proforma invoice and a standard invoice. A proforma invoice is used to create a sale while an invoice is used to generate payment for sale. Unlike an invoice which is final, a proforma invoice may go through a number of iterations before it becomes acceptable to both the buyer and the seller, especially in the case of international trades.
Also, an invoice states what amount is due after some goods have been delivered while a proforma invoice is sent pre-order and is a declaration and show of commitment by the seller to deliver a number of products on a specified date and time.
A quotation is a less formal way – than a proforma invoice - of presenting a cost estimate of a service or product to a buyer and is usually sent during the very early stages of the sales process. It is designed to give the buyer a rough idea of the price and quantity of products to be delivered rather than provide detailed information of the goods to be delivered (proforma invoice).
A company or buyer may receive different quotes from different suppliers on the cost of a product(s). From these quotes, the company chooses a supplier to work with. Following some rounds of negotiations, the seller issues a proforma invoice to the company to have them confirm all that has been ordered and the agreed price.
A proforma invoice must not be recorded as account payable or account receivable because it is not a true invoice. It has no fiscal value and hence, should not be entered in your accounting records.
Understanding the difference between these terms will save you costly mistakes like violating trade regulations or paying for an invoice twice.
What Should Be Covered in a Pro Forma Invoice?
It is worthy of note to know that there is no particular construct for a proforma invoice since it is not considered a legal document. The company generating it is at liberty to follow any format or construct. While there is no specific format required, a proforma invoice would usually contain:
- Invoice Header: The header should contain the title “Pro forma Invoice" or “Pro Forma invoice”.
- Company/business logo
- Product quantity
- Seller or buyer contact details
- Product description and agreed prices for product
- Shipping costs and taxes, if applicable.
A typical proforma invoice designed for export sales should contain the following:
- Product price
- Product quantity and weights
- Detailed description of the product such as its classification and country of origin. In the United States, the six-digit harmonized system or Schedule B number is used to classify products and dictates the duties and taxes to be paid on the shipment.
- Terms of delivery like origin of package and delivery location
- Expiration date of the invoice
Unlike a standard invoice, a pro forma invoice should not have an invoice number. Adding an invoice number makes the document legally binding. It also does not necessarily include a payment due date or exact date of delivery.
Can Payment Be Made on a Proforma Invoice?
A seller may require their buyer to make an upfront payment based on an initial agreement. In this case, a payment can be made on a pro forma invoice. Using the pro forma invoice, the buyer’s accounts payable department may make payments in advance.
To avoid double payment of a part or full payment as the case may be, the seller may make reference to the proforma invoice.
When to Use Proforma Invoices?
Issuing a pro forma invoice shows you are ready to fulfill your own end of the bargain as all agreements have been made up front. It is ideal to send a pro forma invoice when:
- You do not have all the details needed to complete a commercial invoice;
- You need to declare ahead of time the value of goods you are shipping. This is needed for a smooth delivery process especially in the case of an international trade.
In some cases, a pro forma invoice may be needed for internal purchasing approval processes.
Do you know how useful a pro forma invoice is? Many don’t. Many business folks mistake it for a quotation, invoice or purchase of order. As highlighted in this article, it is different from all three and an important ingredient in any seller-buyer mix.
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