What is a Proforma Invoice? Why and How to Use it?

What is a Proforma Invoice?

A proforma invoice is a preliminary or initial document issued by a seller to a prospective buyer before a sale is completed. It acts as a draft bill of sale, outlining the expected goods or services, estimated costs, taxes, shipping expenses, and other information. These invoices offer buyers a clear view of the proposed transaction conditions and allow for negotiations before closing the deal. They are often utilised in international trade and bulk purchasing.

Use Cases of a Proforma Invoice

Preliminary Sales Discussions

A proforma invoice is frequently used during preliminary sales negotiations when a buyer has shown interest, but the transaction has not yet been completed. In this scenario, the seller offers a full cost estimate for the proposed transaction, including item descriptions, quantities, and price. This document allows both parties to negotiate terms and clarify expectations before committing to the sale.

Commitment with Pending Details

Proforma invoices are generated when the buyer is interested in buying but specific information or final confirmations are still pending. For example, the buyer may agree on a general price and quantity but still need to clarify the shipping details or invoice payment conditions. This use case is particularly beneficial in maintaining transparency and ensuring that both parties clearly understand the transaction before it is formally executed.

International Transactions

Proforma invoices are important in international trade because they help in seamless transactions. They are often required for customs clearance since they declare the value of the items being supplied. The seller issues a proforma invoice to the buyer, including detailed product information, shipping costs, and applicable taxes. Thus, sellers can avoid delays and complications in international shipping by using a proforma invoice.

Bulk Orders and Advance Payments

When dealing with bulk orders, sellers typically use pro forma invoices to lay out the prices and terms involved with such transactions. This document is a formal request for an advance payment or deposit from the buyer, ensuring that all parties agree on the deal’s financial terms before moving forward. The proforma invoice clarifies the total amount owed, payment options, and any discounts for early payment, resulting in a smoother transaction procedure.

Financing and Credit Arrangements

Proforma invoices are sometimes required when purchasers seek financing or credit arrangements. Many financial institutions need a proforma invoice as proof of intended purchase before providing loans or credit lines. The documentation explains the products or services being acquired, allowing lenders to examine the transaction’s legitimacy. Sellers can speed up the financing process by releasing a proforma invoice, allowing purchasers to get the cash required to complete the acquisition.

Format of Proforma Invoice

Examples of Proforma Invoice

Let’s imagine you’re a furniture manufacturer, “Elegant Designs,” that specialises in custom-made furniture. A potential buyer, “Home Decor Co.,” expresses interest in ordering 20 bespoke dining chairs. Before finalising the sale, Home Decor Co. wants to understand the overall costs involved, including production, shipping, and any applicable taxes.

In this scenario, you issue a pro forma invoice to Home Decor Co., which includes the following details:

Title: Proforma Invoice

Date: September 13, 2024

Seller Information: Elegant Designs, 123 XYZ, Kolkata

Buyer Information: Home Decor Co., 456 ABC, GUWAHATI

Description of Goods: 20 custom dining chairs

Quantity: 20

Unit Price:  ₹15,000 per chair

Total Estimated Cost:  ₹3,00,000

Shipping Charges:  ₹7,000

Estimated Delivery Time: 4 weeks

Payment Terms: 50% deposit upon approval, balance due before shipment.

Disclaimer: “This is a preliminary invoice for estimation purposes only and not a demand for payment.”

This proforma invoice allows Home Decor Co. to verify the terms and confirm they are within their budget before making a final decision. It also gives a detailed breakdown of the estimated expenditures, which aids in obtaining internal approval for the purchase.

Example 1 of Proforma Invoice

Example 2 of Proforma Invoice

What is the Purpose of a Proforma Invoice?

Transparency and Avoiding Misunderstandings

A proforma invoice is primarily issued to offer the buyer an accurate and comprehensive representation of the intended transaction. This invoice ensures that both parties have a shared understanding of the agreement’s terms by outlining the specifics of the goods or services being sold, including prices, quantities, and any applicable taxes or shipping costs. This transparency helps to avoid miscommunications and misunderstandings that could arise later in the sales process.

Opportunity for Negotiation

A proforma invoice initiates discussions between the buyer and seller, allowing parties to evaluate and modify terms and conditions before finalising the transaction. If the buyer has any concerns regarding cost or logistics, they may negotiate for better deals. This flexibility is especially beneficial in dynamic business scenarios, ensuring that both parties are satisfied with the final agreement and lowering the possibility of any disputes.

Prevention of Disputes

One fundamental purpose of a proforma invoice is to prevent potential disputes between the buyer and the seller. It acts as a legally binding document, providing evidence in the event of a disagreement and facilitating effective issue settlement. This promotes healthy connections and seamless interactions.

Reasons Why Businesses Use Proforma Invoices?

• Transparency in Pricing: Offers a clear breakdown of costs, preventing misunderstandings about the total amount due.
• Facilitating Pre-sales Commitments: Acts as a preliminary agreement, encouraging buyers to commit to a purchase by outlining expected deliverables and pricing.
• Opportunity for Negotiation: Allows for discussions and adjustments to terms before finalising the sale, enabling negotiation on pricing, delivery times, and payment terms.
• Streamlining Internal Processes: Aligns internal approvals and workflows, ensuring all stakeholders are informed before proceeding with a sale.
• Supporting International Transactions: Often required for customs clearance, providing essential shipment details and value.
• Reducing Payment Delays and Disputes: Clearly outlines payment terms and expectations, minimizing potential disputes and delays.
• Enhancing Customer Confidence: Demonstrates professionalism and transparency, builds trust, and increases the likelihood of closing sales.

Note: Proforma invoices are not legally enforceable and are used as estimates or proposals rather than final agreements. They should not be documented in accounts receivable since they do not reflect a completed sale or payment demand. Additionally, they generally can’t be used for tax reclaim, such as VAT, because they are not formal invoices.

How to Create a Proforma Invoice?

Using Invoicing Software

Many accounting and invoicing software solutions offer proforma invoice features, allowing users to create professional-looking documents quickly. To generate a proforma invoice with software:

• Enter important details such as buyer, seller, item details, quantities, and prices.
• The software will calculate taxes, shipping, and the total amount due.
• Customise with your logo and branding.
• Review for accuracy and send to the buyer electronically.

Creating a Proforma Invoice in Excel

Microsoft Excel is a popular method for customised invoices. To create a proforma invoice in Excel:

• Download a free template or create a custom one.
• Add seller and buyer details, item info, quantities, and prices.
• Include your company logo for a professional look.
• Review the invoice for accuracy, then save it as a PDF or send it electronically.

Using Proforma Invoice Generators

Online proforma invoice generators are web-based solutions that offer a specified format with all of the required data. To make a proforma invoice with a generator:

• Select “proforma invoice” from the available document types.
• Enter your business and buyer details.
• Add your logo and branding if needed.
• Review and download as a PDF or send it electronically.

What are the Fields Included in the Proforma Invoice?

• Title “Proforma Invoice” to clearly identify the document.
• Unique invoice number for tracking purposes.
• Date of issue and delivery date.
• Seller’s company name, contact details, address, and bank account details.
• Buyer’s company name, billing address, and shipping address.
• Description of goods or services with quantity and unit price.
• Total quantity and price of each item.
• Discounts or additional charges.
• Applicable taxes and total amount due.
• Payment terms, including due date and accepted methods.
• Shipping details like weight, handling costs, and carrier.
• The validity period of the offer.
• Terms and conditions of the transaction.
• Signature and contact information for follow-up.

How is a Performa Invoice different from a Regular Invoice?

Here’s a comparison table between proforma invoice vs invoice:

Frequently Asked Questions

1. Is GST applicable on a proforma invoice?

No, GST is not applicable on a proforma invoice since it is not a final invoice. It serves as an estimate and does not constitute a sale. However, after the sale is completed, GST will be applied to the final invoice.

2. Is the proforma invoice a valid document?

A proforma invoice is a valid document only for estimating costs and outlining the terms of a potential sale to the buyer. However, it is not considered a legally binding contract. It can be used for internal approvals and negotiations.

3. Can the proforma invoice be cancelled?

Yes, a proforma invoice can be cancelled at any time before the sale is finalised. The buyer should be informed of the cancellation. It is advisable to issue a cancellation notice for clarification.

4. Is a proforma invoice a legally binding document?

No, a proforma invoice is not a legally binding document. It only serves as an estimate outline and does not obligate the buyer to make a payment. A regular invoice issued after the sale holds legal weight.

5. Can we use a proforma invoice to gain advance payments?

Yes, a proforma invoice can be used to request advance payments from the buyer. It outlines the expected costs and terms, providing a basis for the buyer to make a deposit. However, it is important to specify payment terms clearly in the document.