Small business basics

What is an invoice?

Understand the makings of a professional invoice, how to create one, and the various ways of invoicing that are available to your business.

March 23 · 8 min read

An invoice is something that business owners tend to have in common. And yes, this includes small businesses and freelancers. This simple document is critical to your business success — it’s how you get paid by your clients and customers.

Basically, without an effective invoicing method in place, getting paid on time can be quite a hassle and can quickly impact cash flow. No one wants to receive late payments late or, worse, receive payments that are a couple of dollars shy of the total amount because of miscommunication with the client. Invoicing is also crucial for proper bookkeeping and accounting.

Whether you’re a freelancer, a service provider, or a small business owner, this article can help you understand the makings of a professional invoice, how to create one, and the various ways of invoicing that are available to your business. Let’s get to it.

Invoice overview

Let’s quickly define an invoice. It’s simply a payment request that you send to your client or customer after fulfilling your obligation to them as a business owner or service provider. The invoice contains an itemized list of goods sent or services provided over a given period. The amount due for each of these line items are then summed together to arrive at the subtotal.

When you send an invoice to a client, it is known as a sales invoice because you sold a good or service and are now requesting payment. When you receive an invoice from your vendor or supplier, it is known as a purchase invoice because you purchased something and now the seller wants payment for it.

Why is invoicing important to business success?

Invoices essentially streamline your business’s bookkeeping, which in turn helps you manage your cash flow better. They act as records for your business and help you stay organized with your monetary inflow and outflow over a given period. You also get to stay on top of important details, such as which clients owe you and when payments are overdue.

As a source document for business accounting, invoices help capture sales transactions. These records are important not just for calculating profit and loss statements but also for tax purposes. As such, it’s important to always keep copies of invoices that you have sent out and those you have received in a safe place.

Other uses of a professional invoice include:

  • For requesting timely payments from customers and clients
  • For keeping relevant sales records
  • For tracking inventory (usually for businesses that sell physical products)
  • For forecasting future sales using historical data

Invoicing is not just helpful to your business alone. The recipient of your invoice can also use it as a record on their end to track their payables within a given period (usually a month). This helps them make sure their accounting books are accurate as well.

Different types of invoices

There are several different types of invoices, including standard invoices, pro forma invoices, amending invoices, timesheets, electronic invoices (e-invoice), VAT invoices, credit/debit memos, and many more.

Which one you create will ultimately depend on the type of business and the service performed. For example, if you want to add value-added tax (VAT) to the total amount due, you’ll create a VAT invoice. On the other hand, if there was an error in the invoicing process and you need to make amends, you’ll create an amending invoice.

An invoice is NOT the same as any of the following:

There are a number of financial documents and forms that are somewhat similar to an invoice, but they never have similar roles. If you’re new to business accounting and bookkeeping, it’s easy to get these documents all mixed up. Let’s break down what an invoice is not.

  • Purchase order

Purchase orders are a request for goods or services sent by a client or customer to a supplier or vendor. Let’s say your small business sells disposable cutlery. Someone wanting to throw a party could write you a purchase order for 100 spoons, 100 forks, 100 plates, and so on. When you receive a purchase order, you’re obligated to fulfill it, and then you send them the invoice afterward to collect payment.

  • Bill

It’s easy to see why a bill can be confused with an invoice. After all, they’re both documents requesting payment for goods sold or services rendered. The main difference here is that a bill is usually issued to collect immediate payment. For instance, you’re at a restaurant, and you want to pay for the food you just ate. The waiter gives you a bill because they’re expecting immediate payment. On the other hand, an invoice is usually sent and settled after an agreed amount of time.

  • Sales receipt

A receipt is what you issue after the client has settled your invoice. It’s simply an official acknowledgment that you have received payment for fulfilling an obligation. In the case of a sales receipt, you issue it after conducting a sale.

Is an invoice a legally binding document?

This is a common question among freelancers and small business owners, especially when disputes arise and they’re looking for some form of legal respite. Here’s the thing, an invoice is not considered a legal document on its own. In other words, just because you sent an invoice to a client doesn’t necessarily mean they’re obligated to settle the amount due or even make a partial payment.

That being said, an invoice can form part of a legally binding agreement where a duly signed contract is involved. Provided the terms of the said contract are met, the invoiced client or customer is legally obligated to settle it. This contract is what makes your invoice a legal document. That’s why any seasoned freelancer will tell you to always get a contract first, even a simple one before you embark on any work for your client.

To form a binding contract, there must be an exchange of value between you and your client, along with a mutual intention to bind yourselves to the agreement. Exchange of value just means you’re providing something to the client (agreed amount of products or services within a specified period), and the client is providing value in return in the form of timely payments.

If any of these components are missing, then you don’t have a legally binding agreement.

What about oral contracts?

You and your client can enter into an oral contract where you both verbally agree to exchange value. In such instances, you can invoice the client based on the oral contract and they are expected to settle accordingly.

However, you should note that even though an oral contract is legally binding, it can be very difficult to prove its existence should one party decide to dispute it or default on their obligation.

Most important elements of a professional invoice

The primary purpose of an invoice is to provide clear details of the business conducted and the resulting payment due. It seems simple enough and in reality, it actually is, provided you include all the relevant information in the document before sending it.

For easier understanding and better organization, let’s break down an invoice into three main sections — header, body, and footer.

Invoice header section

The header contains identifying information about your business (logo, company name, etc.), as well as relevant information about the recipient of the invoice. These include:

  • Contact information — Include your contact information and that of your client, as you would in a formal letter.
  • Invoice number — The invoice number is a unique number that you assign to each invoice so you can easily identify it. If you need to reference that invoice for some reason, maybe when sending a reminder to the client, or if the client raises a dispute, it’s that invoice number that you’ll use to identify the invoice in question.
  • Invoice date — The invoice date is the date on which you create and send the invoice.
  • Business tax ID — If your invoice includes collecting VAT, sales tax, and other relevant taxes, you’ll need to include your business tax ID in the header section as well.

Invoice body section

The invoice body contains the main details about the goods sold or services provided and other relevant information regarding the sale. These include:

  • Itemized list of goods or services sold for that period — These line items should be listed in detail — describe each good sold or service rendered, the cost per unit or hourly rate, the quantity sold or billable hours expended, and so on. Include as many line items as needed to cover all the information.
  • Subtotal — Sum up all the costs associated with the line items to arrive at the subtotal amount due.
  • Additional billable expenses — If you had to incur some additional expenses outside of your goods or services’ usual costs, include them after the subtotal. For instance, if your usual per-hour billing is $20, but the client requested a rush order and agreed to pay an additional $5 per hour, including the figure. Another example is shipping charges.
  • Discounts and waivers — If you’re giving the client a discount or fee waiver, include it in the invoice and subtract it from your amount due.
  • Taxes — Sales tax, VAT, and other relevant taxes that you’re charging to the client should be included.
  • Total amount — This is the final amount after all the calculations have been made. It is the amount the client or customer is expected to settle on or before the due date.
  • Due date — The due date of the invoice should be fully settled by the client. There’s usually a set amount of time between the invoice date and the due date (usually three to seven business days). Though your client can also issue an immediate payment as soon as they receive the invoice.

Invoice footer section

This section mainly contains payment terms, special instructions, and any other relevant information that the client should know about. These details include:

  • Payment method —This is one of the important information regarding payment terms. How do you want to get paid? PayPal? Direct bank transfer? Cryptocurrency? There are so many possibilities. The key is to include payment methods that are most convenient for your client — options that allow them to settle the invoice with their debit or credit card easily.
  • Special instructions — This mainly deals with additional info about the payment to be made. For instance, you could include information on possible discounts if the client chooses to make an early payment or list down possible penalties for late payments or if they only make partial payments as of the due date. Just remember that to include these terms in your contract so that they become enforceable.

Assigning invoice numbers

Now it’s likely that you’ll be sending out invoices to different clients and customers. It’s important to know how to assign invoice numbers for each client, so there is no confusion. There are different approaches you can utilize. These include:

Sequential

By far the simplest method of assigning invoice numbers. All you have to do is assign sequential invoice numbers — #0001, #0002, #0003, and so on. This allows you to stay consistent with your numbering system and prevents you from assigning duplicate invoice numbers.

Chronological

This just means being able to sort the invoices by date. The first series of invoice numbers start with the invoice date and then followed by the unique numbers. For instance, if you created the invoice on April 20, 2020, and the unique number is 007, the full invoice number will look like 4-20-20-007.

Customer ID

If you have numerous customers or clients, you could assign a unique ID to each of them and then use that ID when assigning their respective invoice numbers. This way, if you need to identify an invoice, you simply search by customer ID. For example, if you assigned a customer ID of A10 and the unique number is 003, then your invoice number will read A10-003.

Project ID

This approach is common in the construction industry because it allows the service provider to work on multiple projects at a time and then invoice the client by the project. To assign the invoice number, you simply need to provide a unique ID for each project followed by the unique number.

Preparing an invoice

There are three common ways to prepare an invoice:

1. Use invoice templates

There are lots of free invoice templates available, even on everyday programs like Microsoft Office and Google docs/sheets. These templates are easy to customize and distribute across your preferred channels. If you’re servicing many clients, you might consider using dedicated invoicing software to streamline the process. These invoice generators provide more customization options, allowing you to give your invoice a more professional look.

2. Use accounting software

Bookkeeping and accounting software typically comes with invoice creation functionalities. Some even allow you to send the invoice via email directly from the app, so you don’t have to worry about saving the document and then attaching it to the email manually.

3. Use a paper invoice

If you’d rather not involve computers and electronic solutions in your invoicing process, you could always do it by hand. Just make sure you’re inputting the correct amounts and line items, or you’ll end up having to start from scratch each time you make an error. An invoice does not look professional if it contains cancellations.

Check out: our step-by-step guide on how to create a professional invoice

Final thoughts

Invoicing is a critical aspect of running a business, even if you’re a freelancer. The good news is the process doesn’t have to be difficult as there are so many options available to you. Simply start by considering what your business invoicing needs are and then choose the solution that works best for you.

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