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An invoice may seem like a straightforward concept: it’s simply a document that states the terms of a sale between a buyer and a seller. However, companies have to deal with various types of invoices that all have different purposes. For instance, proforma invoices contain a lot of the same information as regular invoices, but the two cannot be used interchangeably.
Understanding the differences between invoices will help you create an efficient accounts payable workflow and avoid costly mistakes, like paying an invoice twice or violating regulations. A proforma invoice gives your customer the opportunity to negotiate the terms of sale, which ultimately supports a strong, long-term business relationship.
What Is a Proforma Invoice?
A proforma (or pro forma) invoice is a preliminary bill of sale sent to a buyer to request payment for goods and services before they are supplied. It is an advanced total, or estimate of the total, that includes the transaction, goods, and total payment details for a sale.
Buyers and sellers can use a proforma invoice in good faith to ensure that the seller delivers the requested goods to the buyer after payment.
Is a Proforma Invoice Legally Binding?
A proforma invoice and a final sales invoice share a lot of the same information. However, a proforma invoice is not legally binding because the terms of sale are still subject to change.
In that sense, a proforma invoice is more like a sales quote than a final sales invoice. That means you shouldn’t record the total amount due under your accounts receivable or use the proforma invoice to reclaim value-added tax (VAT).
Proforma vs. Other Types of Invoices
The purpose of a proforma invoice is to provide the final details of an order to the buyer before they commit to a purchase. With this good faith estimate, a buyer can then decide whether or not to continue with the sale.
Proforma Invoice vs. Invoice
While an invoice is official and legally binding, a proforma invoice simply sets expectations for both the buyer and seller. In contrast, a standard or official invoice is recorded in your accounts payable or accounts receivable to be used for accounting purposes in case of an audit.
In the accounts payable process, a proforma invoice is used to create a sale, while an official invoice confirms the sale.
A proforma invoice typically includes all of the information found in a standard invoice, but it should be clearly marked as “proforma.” To avoid duplicate payments, consider including a reference to the proforma invoice number on the standard invoice.
Proforma Invoice vs. Commercial Invoice
Proforma invoices and commercial invoices are both export documents commonly found in international trade. However, the main differences are in how they are used.
Buyers use a proforma invoice to overcome import restrictions that could affect the sale. For example, buyers can use a proforma invoice to demonstrate to the government why they need an import permit. This helps them to more efficiently prepare to receive the shipment.
In comparison, a commercial invoice is used by customs to assess the duties, taxes, and other import fees associated with the sale. A commercial invoice also provides crucial instructions to the freight forwarder, import broker, marine insurance company, and the buyer’s and seller’s banks.
Proforma Invoice vs. Purchase Order
At face value, a proforma invoice sounds the same as a purchase order. Both documents contain the following:
- Descriptions
- Quantities
- Prices
- Discounts
- Payment terms
- Other terms of the sale
However, the difference between a proforma invoice and a PO is their origin: The seller prepares and sends a proforma invoice to the buyer. When it comes to a purchase order, it’s the buyer (and their accounts payable department) who issues and sends it to the seller and uses the document for invoice matching when disbursing payment.
A purchase order is considered a commercial document, meaning an official confirmation of a sale, while a proforma invoice is a quote from a sale, not a confirmation. That’s why the terms in a proforma invoice are still subject to change, while a purchase order is a legally binding agreement.
Proforma Invoice Examples
A proforma invoice is not an official confirmation of a sale, which means the buyer and seller can still negotiate the terms.
Here’s how a proforma invoice would be used in a manufacturing use case:
Let’s say a clothing manufacturer called ABC Clothing receives an order for 5,000 shirts. After receiving the order, ABC Clothing immediately begins production without discussing it with the buyer.
Once they complete production, ABC Clothing sends an official invoice to the buyer. However, the buyer is dissatisfied because they wanted an earlier delivery date and longer payment terms, plus they could have negotiated a lower price.
At this point, ABC Clothing could still salvage the sale by rushing to meet the delivery deadline, voiding the original invoice, and creating a new one with prices and payment terms the buyer agrees to. However, this adds unnecessary time and chaos to their workflow.
In order to avoid this situation, ABC Clothing could create a proforma invoice instead. After receiving the order, the clothing manufacturer would create a proforma invoice that includes:
- Details like the price for 5,000 shirts
- Expected delivery date
- Suggested payment terms
- Early payment discounts
Once the buyer receives the proforma invoice, they can negotiate the terms of sale, such as an early payment discount. If ABC Clothing accepts these terms, they will send an updated proforma invoice for both parties to agree on as a good faith estimate; only then do they begin production.
Finally, they can use invoicing software to generate an official invoice using the information provided in the proforma invoice. This saves them even more time in the sales process.
When Does the Seller Issue a Proforma Invoice?
Proforma invoices are typically used for export sales when a commercial invoice is not yet available—or in other words, when the seller still has to pay for the goods. U.S. Customs requires that the proforma invoice contains adequate information for examining the goods and assessing duties. If the seller already paid for the goods, then U.S. Customs requires a commercial invoice.
A proforma invoice is not limited to just the import of goods. A seller can create a proforma invoice anytime at the request of the buyer, so both parties know exactly what to expect from one another.
What Information Is Required in a Proforma Invoice?
When used for export sales, a typical proforma invoice should contain the following information:
• Detailed descriptions of the goods, such as the country of origin and the product classification (the six-digit Harmonized System or Schedule B number) that U.S. Customs uses for determining duties and taxes
• Price of the products
• Delivery terms, such as the package origin and the delivery location
• Validity or expiration date (or how long the price is valid for)
• The term “proforma invoice” so the buyer knows it’s not a sales or tax invoice
An official invoice is a non-negotiable instrument and must contain a handful of specific information, like the invoice number and date, due date, and payment terms. It should also have:
• Your company’s name, address, and contact information
• Your customer’s name and billing address
• Date of goods delivered
• Details of products
• Total amount due, including shipping costs and applicable taxes
Why Do Businesses Use Proforma Invoices?
A proforma invoice streamlines the sales process because it ensures both parties have agreed to the terms from the beginning. This eliminates any back and forth between the buyer and seller that could result in additional production costs, rushed delivery, or an unhappy customer.
If your business uses invoicing software, proforma invoices can offer an additional time-saving benefit. With the information in a proforma invoice, the software can automatically generate an official invoice after the sale has been confirmed.
Additionally, some businesses might require proforma invoices for their internal purchasing approval process. However, the buyer still needs an official, legally binding invoice to use for their accounts payable records.
Pro forma invoices are also used for international trade. They are typically required by U.S. Customs when a seller wishes to export product prior to sending a commercial invoice.
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Follow These Best Practices to Seamlessly Handle Proforma Invoices
Since a proforma invoice is a quote rather than a confirmation of a sale, the terms are subject to change before the final invoice. That’s also the reason why accounting does not record a proforma invoice—it’s not a real invoice. However, buyers can still follow best practices when it comes to handling proforma invoices:
- Don’t stray too far from the proforma invoice: While the proforma invoice is subject to change, it still should be as close to the actual sale as possible.
- Include transferable information: When dealing with export sales, advise sellers that their proforma invoices should contain information that is transferable to create other forms, such as a commercial invoice.
- Make a note of the date of the proforma invoice: Items like material costs, international fees, and currency rates have fluctuating prices that will rise and fall depending on the market.
Summing It Up
Although pro forma invoices are not legally binding, they are essential documents to keep the procurement process running smooth. Pro forma invoices are used for a variety of reasons, including:
- To facilitate a deal
- Streamline international trade
- Complement invoicing software
- Internal purchasing approval
- And more…
Since a pro forma is more like a quote, the terms are subject to change.
Ultimately, a pro forma invoice is a flexible document that ensures both parties are on the same page and creates a foundation for the sale to happen.
