What HMRC says a proforma is, what Business Central’s prepayment invoice posts, and how to keep the two from tangling
A customer wants your goods, but you won’t ship until they’ve paid. Their finance team needs a document before they can release the money. In a Business Central shop there are two quite different ways to answer that request, and they are easy to confuse:
- A proforma invoice. This is a request for payment that sits outside your ledger. It sets out what the buyer will be charged if the sale goes ahead.
- A prepayment invoice. This is a real invoice that Business Central posts against the sales order. The final invoice then deducts it.
Both “ask for money up front”, but they have different VAT consequences and leave different traces in your books. This article sets out what UK VAT guidance says about the first, what Microsoft’s documentation says about the second, and some housekeeping that keeps them from tangling. It is general information drawn from the sources linked below, not tax or accounting advice. If your situation has any wrinkle, check it with your adviser or HMRC.
What HMRC says a proforma is (and isn’t)
HMRC’s VAT guide (Notice 700) covers pro-forma invoices in paragraph 17.3. The guide describes them as documents offered to potential customers, where the goods or services won’t be supplied unless payment is received. It makes three points that matter in practice:
- A pro-forma invoice cannot be used as evidence to reclaim input tax, even if it shows all the details required for a VAT invoice.
- It should be clearly marked “this is not a VAT invoice”.
- If you go on to supply the goods or services, or receive payment, you then issue a proper VAT invoice.
Paragraph 19.5.1 says the same thing from the buyer’s side: an invoice marked “pro-forma” or “this is not a tax invoice” can’t be used as evidence for reclaiming input tax.
So a proforma is a commercial document, not a tax document. Its job is to get a purchase order raised, a budget approved or a payment released.
What changes when the money arrives
The VAT timing comes from the tax point rules. Under paragraph 14.2.2 of the same guide, if you issue a VAT invoice or receive a payment before the basic tax point, the tax point is the date you issue the invoice or receive the payment, whichever happens first. Paragraph 14.2.3 adds that most deposits are advance payments and create a tax point when you receive them. Some don’t, such as refundable security deposits on hired goods.
Put the two together and the sequence for a UK VAT-registered seller usually runs like this:
- Sending the proforma creates no tax point. It isn’t a VAT invoice.
- The customer’s payment usually does create one, on the day it’s received.
- A proper VAT invoice should follow, and the proforma doesn’t take its place.
That third step is where Business Central’s prepayment feature comes in.
What a prepayment invoice does in Business Central
Microsoft’s Invoice prepayments overview describes prepayments as “payments that are invoiced and posted to a sales or purchase order before you post the final invoice”. The rest of the documentation fills in how they behave:
- They post. The setup article has you add sales and purchase prepayment accounts to the General Posting Setup. Sales prepayments sit in a liability account until the items ship, and purchase prepayments in an asset account until the items are received. Each VAT identifier needs its own G/L account.
- They’re numbered. You fill in Posted Prepmt. Inv. Nos. and Posted Prepmt. Cr. Memo Nos. in Sales & Receivables Setup. Microsoft notes that prepayment invoices can share a number series with regular invoices or use a separate one, but separate series must not overlap.
- They come off the final invoice. The Create prepayment invoices article says that when you post the rest of the invoice, “the prepayment amount will automatically be deducted from the amount due.”
- They can gate the order. A paid prepayment can move the order from Pending Prepayment to Released through job queue entries (codeunits 383 and 384). The Check Prepmt. when Posting toggle stops anyone from posting an order that still has prepayment amounts outstanding.
- You can preview before posting. Prepayment → Prepayment Test Report prints a test version before Post Prepayment Invoice commits anything.
Microsoft’s caveats are worth reading before you switch this on. It recommends against a 100% prepayment in North America, and in any region if you deduct payment discounts manually. With 100% prepayment you also need an Invoice Rounding Account on the customer posting group, or the prepayment invoice won’t post. To delete a line that has already been prepayment-invoiced, you first issue a prepayment credit memo.
Choosing between them
| Situation | Usually fits |
|---|---|
| The buyer needs a figure to raise a PO or get approval, and nothing is agreed yet | Proforma |
| Customs or a freight forwarder needs a declared value before shipment | Proforma |
| The order is agreed and you want a deposit invoiced, tracked and deducted from the final bill | Prepayment invoice |
| The buyer has paid and needs a document they can use for VAT | A VAT invoice, which in BC can be the posted prepayment invoice |
Plenty of businesses use both. The proforma gets the payment approved. When the money arrives, the posted prepayment invoice (or a full invoice) becomes the VAT document.
Keeping a proforma that lives outside the ledger tidy
Business Central doesn’t post a proforma. Teams often produce it some other way: printing from an unposted document, a Word template, an Excel sheet or a separate tool. That’s fine, as long as a few habits stop it from leaking into the books:
- Give proformas their own number series. Use something like
PF-2026-014, which can never collide with posted invoice or prepayment numbers. This follows the same no-overlap principle Microsoft applies to prepayment series. - Mark it as HMRC describes. Head it “Proforma invoice” and state “This is not a VAT invoice”.
- Carry the link. Put the sales order number and the customer’s PO reference on the proforma. When the payment is received, enter the proforma number in Your Reference or External Document No. on the order. That way the posted documents can be searched back to it.
- Give it an expiry date. A proforma with no validity date is a price you might be held to months later.
- Re-check before invoicing. Quantities shipped, actual freight and any price changes should come from what really happened, not be copied over from the proforma on trust.
Purchasing teams should apply the same rule in reverse. A supplier’s proforma is not a document to post as a purchase invoice and reclaim VAT on. Either use purchase prepayments, or wait for the supplier’s VAT invoice.
For teams that make proformas outside Business Central, InvoiceWorkshop’s proforma invoice generator is one option we built. It produces a proforma as PDF, Word or Excel and keeps the document on your device. Once the sale is confirmed it converts the proforma into an invoice with its own number, keeping a reference to the proforma it came from. Whatever you use, the checks above still apply. The posted VAT document still has to be raised in your accounting system.
The short version
A proforma asks for money, and a VAT invoice accounts for it. In Business Central the prepayment invoice is the tool that posts the deposit, carries the VAT and deducts itself from the final bill. A proforma is a separately numbered request, clearly marked as not a VAT invoice, that sits outside the ledger. Kept apart like that, your auditor can trace each one to the other, and nobody ends up reclaiming VAT on a document HMRC says they can’t.
This article was written with AI assistance and checked against the HMRC and Microsoft Learn sources it cites.