Understanding Proforma Invoices
So, you’ve been asked (either as a freelancer or small business owner) for a proforma invoice. In my experience, it’s bigger companies that generally ask for these and so perhaps you’re keen to supply what’s requested. But what is one? Why do they need it? And what needs to be on it? We’ve got you covered and we have a template at the end.
For anyone who gives even the tiniest little damn about the etymology (me… it’s only me, isn’t it?), the term “proforma” originates from Latin, meaning “for the sake of form” or “as a matter of form.”
In a financial context, it typically refers to financial statements that are based on hypothetical or projected figures rather than actual ones.
What is a Proforma Invoice?
A proforma invoice is a document you send to your client before the sale is finalised. It can be useful in helping your client to see pricing estimates and project the cost of your services.
In essence, a proforma invoice serves as a “good faith” agreement between the seller and the buyer, allowing the buyer to understand the transaction details before you finalise the agreement.
Why would you send a proforma invoice?
In all honesty, the only reason I would ever send one is because a client asks. And this has happened a few times.
So why might a client ask? Well, there are three common use cases:
- It’s part of their procurement process as standard which is often because proforma invoices as typically seen as more final in their pricing than a quote
- Sometimes it is required to get products being sent overseas cleared through customers in cases where the invoice isn’t issued until the client receives goods
- Proforma invoices can help clients to confirm the cost of services before agreeing a final contract. This can be particularly useful if they’re securing outside finances to engage your services
Is a Proforma Invoice Legally Binding?
Although a proforma invoice contains much of the same information as a final sales invoice, it does not carry the same legal weight. It is not intended for accounting purposes and should not be treated as a binding agreement.
A proforma invoice is actually more similar to a quote or estimate than to an invoice.
The total due is not recorded under the customer’s accounts payable or the seller’s accounts receivable, and a proforma invoice cannot be used to reclaim VAT.
The customer does not owe the amount stated on a pro forma invoice.
In the UK, proforma invoices are not considered commercial invoices and are therefore not subject to the same regulations. For instance, it’s not mandatory to include VAT details on a proforma invoice, as HMRC specifies that they cannot be used to reclaim VAT.
However, including VAT information can be beneficial. Since proforma invoices are often viewed as draft invoices, it’s useful to make them as accurate as possible to give customers a clear understanding of the expected costs.
How Does a Proforma Invoice Differ from Other Types of Invoices?
To better understand where a proforma invoice fits into the sales process, it’s helpful to compare it with other common invoice types:
Sales Invoice: A formal request for payment sent at the time goods or services are supplied, or shortly after. It also serves as a tax document, often including VAT.
Commercial Invoice: Used in international shipments, this invoice declares to customs officials and the customer what is being shipped, who is involved, and the sale terms. It is used to calculate the value of goods and applicable taxes.
Credit Memo: Issued when goods are damaged or errors occur, a credit memo provides details of a refund or credit against future purchases.
Proforma Invoice: Provides a preliminary estimate of costs, helping the customer decide whether to proceed with the purchase.
Proforma Invoices and Tax
A proforma invoice does not establish the tax point of a transaction, which is the date on which the sale occurs for VAT purposes. For example, if you’re supplying raw leather materials, you might send a proforma invoice to a customer to outline the proposed sale details before the exact dimensions are confirmed. The tax point occurs when the final sales invoice is issued after the customer agrees to the purchase.
Since a proforma invoice is not legally binding and is not used for official accounting purposes, it does not need to be cancelled if the sale does not proceed. Like a quotation, if the transaction doesn’t go ahead, no further action is required.
However, it’s important to monitor your incoming and outgoing payments to understand how a cancelled order might impact your cash flow.
How to Create a Proforma Invoice
Creating a proforma invoice is straightforward and can be done using the same method as creating regular invoices. Many accounting or invoicing software programs offer proforma invoice templates, or you can create one manually using applications like Microsoft Word or Google Docs.
What Should You Include on a Proforma Invoice?
The primary purpose of a proforma invoice is to detail the proposed transaction for your customer. It should include:
- Your company’s name, address, and contact details
- The customer’s name and address
- A description of the goods or services
- VAT information (although not a tax invoice, it’s useful to show the expected VAT amount)
Unlike a final sales invoice, a proforma should clearly state:
- “Proforma Invoice” so the customer knows it’s not a final sales or tax invoice
- The phrase “This is not a tax invoice”
Free Proforma Invoice Template
So it’s not difficult at all to create these. But if you’re not using accounting software that has the facility to automatically create you one, we have you covered with our proforma invoice downloadable template:
Here’s how to use it:
- Visit this link: Free downloadable proforma invoice template
- That will prompt you to make a copy of the Google Doc
- Make the copy (you’ll need a Google Account to do this)
- In your copy, amend the details to your business, your client and your services. There’s a space for you to put your logo in or you can just remove the logo if you prefer
- Once complete, to go file >> download and then choose whether to download as PDF or Word File. If it’s to be sent straight to the client, I would generally go PDF! But that’s your choice
And that’s it! All the key information you need to know about proforma invoices.
