What Is Proforma Invoice? How And Why To Use It?

Invoicing plays a major role in financial accounting. It allows an organization to keep track of the payments received and sales made over a specific period of time. Interestingly, not all invoices are used for accounting purposes. Some of them are used to give buyers an idea about the transaction that is about to happen. 

A Proforma invoice is one such invoice.

What Is A Proforma Invoice?

A Proforma invoice is an estimated invoice, also known as a preliminary bill, used for requesting payment from suppliers/buyers before the exchange has taken place. As opposed to the conventional sales invoice, a proforma invoice contains estimated details about the transaction that would occur in the future. 

However, the details mentioned within a proforma invoice are not vague. Just like any other invoice, it contains the description of goods to be supplied, their precise cost, overhead expenses (if any), and all other charges levied to the buyer. A proforma is essentially a “good faith” agreement between you and the buyer of your goods to let them know what to expect from the actual sales transaction.

Why Is A Proforma Invoice Raised?

A proforma invoice is often raised by an organization if full or part payment is required to secure financing before goods are manufactured. Such invoices are commonly raised for carrying out international trading transactions. 

Moreover, a proforma invoice is created only when the concerned customer has agreed upon buying the pre-decided amount of goods from an organization. Although it is an estimate, most details mentioned in a proforma invoice remain unchanged when an actual sales invoice is created after the transfer of goods. 

Does A Proforma Invoice Bind Legally?

Although most details mentioned in a proforma invoice are more or less similar to the ones mentioned in the final sales invoice, it holds negligible legal weight and cannot be used for accounting purposes. It also cannot be used as a legally binding agreement as it is not a completely precise record of your transaction. 

It is safe to say that a proforma invoice is similar to an estimate or a quote given by your organization to your suppliers or buyers before they make the purchase. As the recipients are not required to pay the amount mentioned in the invoice, the same cannot be recorded in your books of accounts under accounts payable. 

Difference Between A Proforma Invoice And Other Invoices

Commercial Invoice

While a proforma invoice is an estimate of a transaction yet to be carried out, a commercial invoice is raised during international shipments for making a declaration to your customers (and custom officials) about what is being shipped. A commercial invoice allows you to calculate the precise financial value of the goods traded by your organization and the taxes that may apply to your transaction. 

Sales Invoice

This is the most common type of invoice raised by businesses. The major difference between a sales invoice and a proforma invoice lies in the fact that the former is raised at the time of (or soon after) the goods being supplied, while the latter is issued before the transfer of goods takes place.

Credit Memo

Used as key source material for your sales returns journal, a credit memo is issued when an organization is required to make a refund to the buyer/supplier in the event of goods being damaged, clerical errors, and other relevant situations. 

Performa Invoice And Taxation

Always note that a proforma invoice is not issued during the tax point of a transaction. “Tax point” is referred to as the day on which the sale takes place for accounting purposes. This is a major element in proforma invoice and tax invoice comparison. While the latter take taxation into consideration as the invoice is created on the date of transfer, the former does not take taxation into consideration as the tax point has not occurred yet.

For tax accounting, the sales invoice generated on the actual date of sale is considered. This invoice can be used for filing tax returns, calculating VAT, and more. On the other hand, a proforma invoice is limited to making as accurate an estimate as possible.

Is It Possible To Cancel A Proforma Invoice?

Technically, there is no need for a proforma invoice to be cancelled as it is not a legally binding document and cannot be used for accounting purposes. Just like sending a quote to your client, you do not need to take any action if the sale doesn’t take place after a proforma invoice is created and sent to the recipient. 

This implies that your customers have an option to cancel the deal and refrain from making any purchase after receiving a proforma invoice. There is no need to officially cancel or edit this document if the deal does not go through. This is the reason why it is important for an organization to maintain good visibility over different aspects of its income and expenses to see how they affect its cash flow. 

How To Create A Proforma Invoice?

Creating a proforma invoice is a fairly simple and straightforward method. It is more or less the same approach followed by an organization to create any conventional invoice. Most invoicing and accounting software platforms would help you create a proforma invoice within minutes. 

Here are the most important elements that need to be added to your proforma invoice:

  • The invoice number
  • The name, address, and contact details of your company
  • The name and address of the customer
  • The date of issue 
  • The due date
  • Detailed description of goods to be sold
  • The price of the goods and their validity (if applicable)
  • Payment terms
  • VAT (although it will not be calculated, it is advisable to give your customer an idea about the VAT they would be required to pay)

The Final Word

These were some basic yet important aspects to keep in mind about a proforma invoice. Before you create these invoices, never make the mistake of taking them lightly and ensure that all the details added to the document are as precise as possible.

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