This is a delicate document, accountants will have one understanding of a proforma invoice, law practitioners have another understanding of the document, and finally, exporters and importers have another use of the document. It is a document that has also divided opinions, some say it is an inconsequential document, while others say preach the document’s importance in the day-to-day shipment planning. We like to take this opportunity to truly walk the tight rope and understand what is a proforma invoice.
A Proforma Invoice is prepared by the seller for the buyer with an intent to offer goods or services spelled out in the proforma invoice, the function of a proforma invoice is therefore akin to a quotation offer. It may not be a legally binding contract, but it serves as a supporting document that is important for the courts to consider. In accounting terms, it cannot replace an invoice as an accounting entry. Despite all that, importers and exporters regularly rely on a proforma invoice in their business operations.
There are many benefits of practicing issuing a proforma invoice for every planned shipment. However, we did some digging and find out that in some instances, it may not be as practical to issue a proforma invoice too. We did some research and here we cover the most frequently asked questions about the proforma invoice.
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What is a Proforma Invoice?
A proforma invoice can be rephrased as a “draft” invoice. Whenever we need something drafted, it generally means that a lot of planning had to revolve around that draft.
A carpenter needs a draft a plan before even starting to saw the wood because once the wood is sawn, it cannot be unsawn.
Among the many, logistics is a job that requires significant pre-planning. It is no wonder that it is frequently used in supply chain management.
Let’s get specific, a “draft” invoice or proforma invoice has similar details when compared to an actual invoice.
The key factor of making the sales transaction viable is that both the seller and the buyer agree to terms with the price, quantity, and promised quality of the goods.
But there is more, the buyers are not the only users of the invoice, the transporters also rely heavily on the invoice information to plan for the logistics operation
The invoice is the root for the preparation of most of the shipping document, here are a few examples: –
The Base for Bill of Lading
When drafting a contract of carriage such as the Bill of Lading, the carriers have to know, without any exception, what they are transporting.
As it is not physically viable to inspect every cargo they ship, that requires many manpower and resource. They base their bill of lading issue with the invoice details, and trust the cargo is loaded as-is.
That is why you might have seen the term “Said to Contain” popping up in the Bill of Lading.
When drafting a contract of carriage such as the Bill of Lading, the carriers have to know, without any exception, what they are transporting.
As it is not physically viable to inspect every cargo they ship, that requires many manpower and resource. They base their bill of lading issue with the invoice details, and trust the cargo is loaded as-is.
That is why you might have seen the term “Said to Contain” popping up in the Bill of Lading.
The Base for Customs Declaration Documents
The transported cargo has to go through the scrutiny of the customs officers on both the exporting country and importing country.
a customs officer will look at the cargo description, quantity, packaging method, and the cargo value to determine whether the cargo is safe for export or import.
Perhaps the more important factor for traders is the applicable customs duty and tax of the cargo. Of course, they are based on the invoice.
Why Do We Use a Proforma Invoice?
The curveball scenario is: –
What if the importer cannot agree to buy from the seller until they find out what are the shipping costs?
Adding to the complexity, in accounting terms, the seller cannot issue an invoice before the sales have been confirmed.
Nowadays accounting systems are all automated. When an invoice is issued, there is a debit entry on the accounts receivable of the seller and a debit entry on the accounts payable of the buyer. But, with sales not confirmed, there should not even be an accounting entry.
With all this in mind, the buyer will request a PI, Firstly, to estimate the total cost of transportation, and secondly to assess the import requirements of the cargo.
Proforma Invoice vs Quotation
In brief, a quotation has the ancillary terms and conditions of the sales, whereas the proforma invoice provides an exact proximation of what the buyer is buying.
To elaborate, a quotation will have some details a proforma invoice don’t and vice versa. For example: –
| Proforma Invoice | Quotation |
| – Specific goods selected by a buyer along with its price, packaging, and quantity. – Shipping INCOTERMs (CIF, CNF, FOB, DDU, DDP, EXW) | – Price validity – A broad selection of goods or services for the buyer to choose – Standard Trading Conditions – Credit Terms |
Having said that, it is entirely dependant on each business practices what to include in a proforma invoice and a quotation. It is possible that they both can be similar.
As an exporter or importer, you can always provide the quotation for freight forwarders or logistics planners to estimate shipping and duty costs.
As long as the document, has the price, packaging, quantity, and shipping terms, a quotation can function as a proforma invoice as well.
We like to use the analogy of ordering in a restaurant as an example to understand the difference between a quotation, a proforma invoice, and an invoice.
| Reading a menu to order | The menu is the quotation |
| Servers writing down the food order | The server’s note is the proforma invoice |
| Getting the bill for the good ordered | The bill is the invoice |
For instance, you may have 1000 SKUs of product readily available for your clients to buy, therefore you prepare a quotation for all the SKUs you have. The client places an order on only 10 SKUs, and proceed to request for a proforma invoice for shipping and duty cost estimation.
Proforma Invoice Accounting
Accounting for a proforma invoice is really straight forward. Don’t.
As we know now, it is used only to assist the buyer’s decision-making process. It is not an accounting document per se.
Although, there are other benefits of issuing a proforma invoice. For outer envelope clients or clients that you do not have any long-standing relationship with, you can issue a proforma invoice with an initial deposit amount as a confirmation of an order.
For example, for a faster accounting process, a seller can generate a proforma invoice with the “50% Deposit 50% Upon Delivery per shipping term”.
Once the buyer has agreed to the sale and proceeded to deposit 50% of the invoice value, you can use the same invoice entry in your invoicing system and generate an actual invoice, with an actual invoice number.
Subsequently, you can issue an invoice without having to go through the process of issuing a new invoice. The date of the invoice is therefore dated properly, which is very important for the accounting process.
This will help the businesses to track and expedite payments.
However, with a quotation, since the quote is not specific to the client’s order, you only can generate an invoice once the client agrees on an order.
Some accounting system has the ability to convert a quotation into an invoice, whereas in most cases there isn’t that function. So, having a proforma invoice that acts as a quotation is also beneficial overall in the accounting administration.
When not to use Proforma Invoice
We have preached the benefits of issuing a proforma invoice, in summary, it assists in: –
- Estimating shipping costs
- Speed up the payment collection process
But, once a seller has a long-standing business with the buyer, that requires an issue of hundreds of invoices a month, it can be cumbersome to prepare a proforma invoice.
Adding to that fact, a proforma invoice mostly does not cover all of the trading conditions, which may make them ambiguous.
Therefore it may be more prudent to provide a quotation with all the necessary trading conditions, and once a new buyer issues a new purchase order, you can prepare a proforma invoice for the buyer’s administrative process, and follow up with an invoice once the shipment is confirmed and the buyer has made the payment.
As time passes, the number of orders stack up, there is a level of trust between the buyer and the seller. The seller can operate with just a purchase order, and fall back to the quotation for all other standard trading conditions.
Legal issues of a Proforma Invoice
We did mention that a proforma invoice does not constitute a legally binding contract between the buyer and the seller. However, it provides some clarity to the courts to determine that the actual contract is made without misrepresentation.
There are many case examples that the plaintiff or the defendant state their case with the use of a proforma invoice. The court will use all the documents and correspondence, arrange it in chronological order, and see whether any addition or omission of information on the documents had materially altered the terms of the contract.
