Proforma Invoice Meaning, Uses, Format and Examples

Proforma Invoice Explained

Proforma Invoice: Before shaking hands on a contract, businesses usually negotiate the terms of the deal, the selling price, discounts, and delivery dates. After these negotiations have been completed, the Company recommends sending a pro forma invoice to the purchaser showing the services agreed upon. This document also serves as a provisional contract and is known as a pro forma invoice.

Pro forma in Latin stands for ‘for the sake of form,’ suggesting that it is only a provisional document and will ultimately be an official document. Although proforma invoices are widely accustomed it is easy to confuse them with recurring invoices. This article seeks to clarify the meaning of proforma invoices using illustrations, explain their uses, and demystify the distinctions between a Proforma Invoice and an invoice.

What Does a Proforma Invoice Mean?

Proforma invoice meaning is a provisional invoice sent to the buyer before the sale is confirmed. This invoice highlights the services provided by the seller, such as the goods or services to be delivered, their prices, delivery information, and delivery dates. After checking the proforma invoice, the buyer provides the green light to the seller. The seller proceeds to transmit a sales invoice and begins operating on their part of the contract manufacturing the outcomes or providing the service.

Is a Proforma Invoice Legally Binding?

Pro forma invoices and final sales invoices contain much of the same information. Nevertheless, a Proforma invoice is not lawfully binding because the terms of sale are still subject to change.

In this sense, a pro forma invoice is more like a sales proposal than a final sales invoice. In other words, don't record total amounts owed in your accounts receivable or use proforma invoices to charge value-added tax (VAT).

When Is a Proforma Invoice Issued?

A Proforma invoice is issued when the seller has discussed preparations for the sale with the buyer. However, since the final details of the transaction have not yet been confirmed by the buyer, we are unable to send a formal invoice. Issue pro forma invoices so buyers know exactly what to expect from sellers.

A Proforma Invoice Use Case:

Assume that a computer domains manufacturer called Cerry Components receives an order for 5,000 computer monitors. Upon obtaining the order, without any negotiation or guarantee, Cerry Components starts procuring the materials for the monitors and begins manufacturing them. Within a month, production will be completed and Cerry Components will invoice the buyer. Examining invoices, buyers are dissatisfied for the following reasons:

• They think the price is too increased and could have been bargained
• They wanted the delivery date before
• They want a lengthier payment duration

So, Cerry Components can still make amends by lowering their prices, streaming to meet the deadlines, nullifying their previous invoice, and making a new invoice that meets the requirements but doing business this way is disorganized and inadequate.

Alternatively, Cherry Components issues a pro forma invoice containing computer monitor prices, delivery dates, and payment terms. The buyer gets the option to negotiate with the seller to find mutually agreeable terms. Once approved, Gary Components will send a pro forma invoice as a good faith document and begin manufacturing computer monitors. Once manufacturing is complete, pro forma invoices can be converted to sales invoices using invoicing software or accounting tools.

Why Do Businesses Use Proforma Invoices?

Proforma invoices streamline the sales process as they confirm that both parties agreed to the terms from the beginning. This eliminates interactions between buyers and sellers that can lead to additional production costs, rushed deliveries, or customer dissatisfaction.

If your business uses invoicing software, pro forma invoices can save you even more time. The details in the pro forma invoice, the software can automatically create a formal invoice after the sale is confirmed.

Additionally, some companies may require a pro forma invoice for their internal purchase approval process. However, the buyer requires a formal and legally binding invoice for the accounts payable. Pro forma invoices used for international trade.

The Fields in a Proforma Invoice:

Unlike invoices, which contain a predefined set of fields, pro forma invoices can have whatever is relevant at the moment of creation. The only visual difference between pro forma invoices and sales invoices is that an invoice number is not required for pro forma invoices, whereas an invoice number is required for sales invoices.

However, Pro Forma Invoices Typically Include the Following Fields:

1. Document titled "Proforma Invoice" 
2. Buyer details such as company name, billing address, and shipping address 
3. Information about the seller, such as company name and address
4. Payment terms
5. Invoice creation date
6. Invoice expiration date
7. Description of the goods or services
8. The prices of the goods and services
9. Quantity of the goods and services
10. Discounts
11. Taxes
12. Total

Pro Forma vs Other Types of Invoices

The purpose of a Proforma invoice is to deliver the final details of an order to the buyer before they engage in a buy. Based on this honest estimate, the buyer can decide whether to proceed with the sale.

Proforma Invoice vs Invoice

While invoices are formal and legally binding, proforma invoices merely set expectations for buyers and sellers. In contrast, standard or formal invoices are recorded in Accounts Payable or Accounts Receivable and comply with accounting purposes during tax audits. The accounts payable process uses proforma invoices to create sales and formal invoices to confirm sales.

A pro forma invoice usually contains all the information of a standard invoice, but must be marked as "pro forma". A reference standard invoice's pro forma invoice number be provided to avoid double-spending.

Proforma Invoice vs Commercial Invoice

Pro forma invoices and commercial invoices are common export documents in international trade. However, the main difference is in usage. Buyers use pro forma invoices to overcome import restrictions that may affect sales. For example, a buyer can use a pro forma invoice to indicate to the government why an import license is required. This allows you to prepare to receive broadcasts more efficiently.

In comparison, Commercial invoices are used by customs to determine duties, taxes, and other import charges associated with a sale. Commercial invoices also contain important instructions for shippers, import brokers, marine insurance companies, and buyer's and seller's banks.

Proforma Invoice vs Purchase Order

At face value, a Proforma invoice expresses identical to a purchase order. Both documents comprise :

• Descriptions
• Quantities
• Prices
• Discounts
• Payment terms
• Other terms of the sale

Nevertheless, the distinction between a Proforma invoice and a Purchase order is their source: The seller designs and sends a proforma invoice to the customer. When it comes to a purchase order, it’s the customer (and their accounts payable division) who issues and transmits it to the seller and utilizes the document for invoice matching when expending payment.

A purchase order is deemed a commercial record. The Proforma invoice is an offer to sell, not a confirmation, but a formal confirmation of the sale. As such, the order constitutes a legally binding agreement, but the pro forma terms of the invoice are subject to change.

Example of Proforma Invoice Format

A pro forma invoice is not a formal proof of sale representing the buyer and allows the seller to negotiate terms. Here's how pro forma invoices are used in manufacturing use cases:

For Instance, a clothing manufacturer called XYZ Clothing receives an order for 10,000 shirts. After receiving the order, XYZ Clothing begins production without discussing it with the buyer. 

Once they finish production, XYZ Clothing sends an official invoice to the buyer. Nevertheless, buyers are dissatisfied because they wished for faster delivery times and longer payment terms and were able to negotiate lower prices.

At this moment, XYZ Clothing could still recover the sale by rushing to fulfil the delivery deadline, abolishing the original invoice, and constructing a new one with prices and payment terms the buyer agrees to. However, this adds excessive duration and confusion to their workflow.

To avoid these circumstances, XYZ Clothing could create a Proforma invoice instead. Upon receipt of the order, the apparel manufacturer will issue a pro forma invoice containing:

• Details like the price for 10,000 shirts
• Expected delivery date
• Suggested payment terms
• Early payment discounts

Once the buyer receives the proforma invoice, they can negotiate the terms of the sale, including discounts for early payment. If XYZ Clothing takes these terms, they will transmit an updated Proforma invoice for both parties to settle on as a good belief estimate; only then do they begin production. 

Finally, invoicing software can be used to generate formal invoices using the information provided on pro forma invoices, which saves even more duration in the deals process.

Example of Proforma Invoice Format in Excel -

When Does the Seller Issue a Proforma Invoice?

Pro forma invoices are typically used for export sales when commercial invoices are not available or the seller has not yet paid for the goods. US Customs requires that pro forma invoices contain sufficient information to examine the goods and determine tariffs. US Customs requires a commercial invoice if the seller has already paid for the goods.
   
Pro forma invoices are not limited to the importation of goods. Sellers can always create pro forma invoices at the buyer's request, so both parties know exactly what to expect from each other.

Follow These Best Practices for the Seamless Processing of Pro Forma Invoices

A Proforma invoice is an offer, not a confirmation of sale, and terms and conditions may change before the final invoice. So, This is also why accounting does not record proforma invoices because it is not the actual invoice. However, buyers can follow best practices when processing proforma invoices. Don’t stray too far from the proforma invoice: Proforma invoices are subject to change but should be as close as possible to actual sales. 

Include transferable information: If you are dealing with export sales, tell the seller that the Proforma invoice should include information on creating other forms as a commercial invoice. Make a note of the date of the proforma invoice: Items such as material costs, international fees, and exchange rates are subject to price fluctuations that go up and down depending on the market.

Can a Proforma Invoice Be Canceled?

As a Proforma invoice is not a legally binding document or the official invoice used for accounting, they do not need to be cancelled. Similarly to a quotation document, if the deal does not go forward, no action is required to edit or revoke the proforma invoice.

That suggests a consumer can alter their mind and not go ahead with an investment even after you’ve sent them a proforma invoice. For this cause, it’s always a good idea to preserve visibility over every element of your incoming and outgoing payments, so you know how a cancelled order may affect cash flow. 

Conclusion

Sending a tentative summary of the deal before confirming the sale in the form of a Proforma invoice streamlines the quote-to-cash process and gives the buyer leeway to review the terms of the agreement before it is done. Businesses scaling fast and examining methods to improve their billing processes should consider using proforma invoices.

If you begin utilizing proforma invoices, check out Zoho Invoice. Zoho Invoice is complimentary invoicing software that allows freelancers and small corporations to develop estimates, convert them into professional invoices, and get paid on time.