Imagine facing this question on a game show:
"Which of the following cannot be used for accounting purposes?"
- A sales invoice
- A proforma invoice
- A tax invoice
The correct answer is "proforma invoice". Would you have put all your money on it? More to the point, if a customer asks for a proforma, do you know what it should and shouldn’t be used for and exactly how to send one?
In this article, we’ll explore the ins and outs of this type of invoice. The first thing to know? Strictly speaking, it isn’t actually an invoice at all.
What is a proforma invoice?
A proforma invoice is a request for payment for goods or services that you anticipate selling to a customer, but that hasn’t been supplied yet.
For example, if payment is required in advance to ensure financing is secured before you manufacture goods or supply a service, a proforma can be used to propose the details of the upcoming transaction. A proforma is essentially a "good faith" agreement between you and a customer so that the buyer knows what to expect ahead of time.
Although a proforma includes much, if not all, of the same information that appears on a final sales invoice, it doesn’t carry the same legal weight and shouldn’t be used for accounting purposes.
In many ways, a proforma is closer to a quote or estimate than an invoice. This is because customers aren’t required to pay the amount listed on the proforma, the total amount due isn’t recorded under the customer’s accounts payable or your accounts receivable, and you can’t use a proforma to reclaim VAT.
The key point to remember is that a proforma is usually sent to a customer or client when they’ve committed to purchasing from you, but can’t be sent an official invoice because the final details still need to be confirmed. Once the customer agrees to everything, then you deliver the goods and issue a formal invoice.
How does a proforma differ from other types of invoices?
To better understand where a proforma fits into the sales process, here are what other common invoice types are used for:
Sales invoice – This is a formal request for payment that’s sent at the same time as, or shortly after, goods or services are supplied. As well as a payment request, it’s also a tax document and, if it includes VAT, it may be called a tax invoice.
Commercial invoice – This document is used in international shipments to declare to the customer and customs officials what is being shipped, who is selling and buying, the date and sale terms, the quantity and weight of goods, and other details. Commercial invoices are used to calculate the value of goods being traded and any taxes that may apply to the shipment. To find out more, read our guide to commercial invoices.
Credit memo – If goods are damaged or there’s been a clerical error or another mistake, this document provides details of a refund for the original sales invoice in part or in full or credit that’s used towards future purchases.
Proforma invoice – Shows how much goods or services will cost to help the customer decide if they want to go ahead with the purchase.
What to include on a proforma invoice
The primary purpose of a proforma invoice is to show your customer the details of the proposed transaction. As such, it should include the same information as the final invoice:
- Your company name and address
- Your customer’s name and address
- The date
- A full breakdown of the product or service
- How long the price is valid
- A link to any applicable terms or conditions
- Full payment details (whether or not the customer makes payment at the proforma stage, it’s worth giving them instructions on how they’ll pay)
- VAT (Although a proforma isn’t a tax invoice, you should still show what the VAT amount is expected to be)
Unlike the final sales invoice, the proforma should include:
- The term "Proforma invoice", so your client knows it’s not a sales or tax invoice
- The phrase "This is not a tax invoice"
Proforma invoices and VAT
A proforma doesn’t fix the tax point of a transaction. The tax point is also known as the "time of supply" – it’s the day on which the sale takes place for VAT purposes. For example, let’s say you’re a supplier of raw leather materials. The size of each leather skin differs and will need to be checked in the warehouse before you confirm the exact dimensions.
You send a proforma invoice to a customer who has enquired about a particular item. On the proforma, you list every detail of the proposed sale. At this point, the tax point hasn’t occurred, and you would not use the date on the proforma in your tax accounting.
The customer confirms they’d like to go ahead and sends payment. You then issue a final sales invoice. The date on this invoice is the tax point and is used for your VAT return.
Now you know all about proforma invoices, you hopefully have one less detail to worry about in your sales process. If you’d like more flexibility in managing your business’s finances, we have a range of solutions that could help. Our Business Cards can help you unlock the buying power to grow your business, all while earning valuable rewards.