Structuring Invoices

Invoices are an important part of any business, as they provide the accounting justification for the movement of money. If you’re a merchant dealing directly with your customers, there’s really no question of how to issue or interpret invoices. But—more likely—if you’re a platform mediating the sales of goods or services between merchants and buyers, there are several different ways to handle invoicing, and it can be quite confusing to understand the various benefits and risks associated with each of the possible invoicing models.

In this article, let’s dive into three different models for invoicing as a platform and look closely at the implications for each. Some of those implications will depend on the region or regions you are operating in, your relationship with your merchants, and the degree of complexity for each of the three parties; It’s best to keep an open mind, and consider using a mix of these models to optimally handle the kinds of commercial situations you might encounter.

The Scenario

So let’s suppose you are a platform facilitating sales of goods, and you charge a flat percentage commission on all sales. You have a merchant with a listing on your platform for which they want to charge $80. And you have a buyer who is purchasing the product for a total of $100—the $80 plus your commission of $20. You collect the entire $100 purchase price, keep the $20 commission, and disburse the remaining $80 to the merchant on behalf of the buyer. How do you structure the invoices for that transaction? There are three options.

Model A: Customer Commission

On this model, both you and the merchant generate invoices to the buyer. The buyer receives an invoice from you for your fee of $20, and an invoice from the merchant for $80 for the product. On this model, the buyer is a customer of both you and the merchant.

This model simplifies your invoicing process, as you are only ever generating invoices on your own behalf, and passing responsibility to the merchant to invoice for the product sale itself. It also reduces the burden on the merchant by keeping their invoicing structure straightforward—the money they receive matches the amount on the invoice they generate.

On the other hand, the two invoices make the commission structure explicit to the buyer, which you might or might not want to do depending on your relationship with your buyers—it creates a risk that they might bypass your platform in the future.

There is an additional complication for the merchant, in that they are receiving funds from you, but invoicing the customer, which could create accounting difficulties for them depending on the accounting and taxation rules where they operate.

Moreover some regions have strict rules on platforms handling money on behalf of merchants (such as PSD2 in Europe), something other commission models handle much better.

Model B: Seller Commission

Another option is to have the merchant invoice the customer directly for the entire purchase price. You then invoice the merchant for the commission. The buyer is only a customer of the merchant now, and the merchant is your customer. This invoicing model is fairly common for platforms operating in Europe.

This is a much cleaner situation from the buyer’s point of view, as they receive only one invoice, and that invoice doesn’t disclose your commission model. It’s also cleaner from your perspective, because your only customers are your merchants.

However, it can place some burden on the merchants, depending on the tax structure where they operate, as they are likely required to recognize the entire $100 price as revenue, and the $20 commission as an expense which they might not be able to apply fully against their revenue. Additionally you will still run into regional rules, like PSD2, on handling funds on behalf of merchants.

Model C: Merchant Mode

There is a third option to consider, a more traditional approach (with a modern twist). On this model, you purchase the goods from the merchant, who invoice you. You then sell the goods directly to the buyer, invoicing them for the full amount. This is the usual model for brick-and-mortar stores that purchase an inventory from merchants for resale in a retail environment. The modern twist is that rather than keeping inventory, you make the purchase from the merchant just as the buyer is making the purchase from you—that is, using a just-in-time logistics model.

The advantage to this model is that invoicing is simple and clean for every party involved. In particular, you are not handling funds on behalf of the merchant. This model works well universally from an accounting and taxation perspective.

However, the downside is that you become the merchant of record for the sale. If the goods need to be returned or repaired, you as the platform become the responsible party for handling that. You can then pass along this responsibility to the original merchant, but you need to trust your merchants for this to work—it is entirely possible for them to fraudulently disappear after the sale is made, and you are left holding the bag. Implementing this model is therefore risky unless you have a demonstrably good relationship with your merchants.

How to Choose an Invoicing Model

Each of the three models presented above presents a different tradeoff of benefits and risks. Almost certainly you should consider your jurisdiction, the jurisdiction of your merchants, the complexity of the transactions, and your level of trust in your merchants on a case-by-case basis, and choose the appropriate model dynamically.

Model C, although straightforward from an accounting perspective, presents the greatest risks to you. Because you are responsible for the goods or services sold, you need to be able to trust your merchants. Moreover, employing this model means that the nature of your business activity might be rather different from a financial reporting perspective—you aren’t transacting as a platform in this case. On the other hand, Model C makes it easier to structure transactions involving multiple merchants because you are not handling funds on their behalf.

Models A and B trade off simplicity to reduce the risks to you of being held liable when a merchant disappears. However, as mentioned above, things get more complicated when multiple merchants are involved in a single transaction. In order to meet certain regional requirements, such as PSD2 in Europe, you will need to use a payment processor to handle the funds on your behalf. This can pose a problem if in a given multi-merchant transaction there is no common payment processor among the merchants. In these cases you will have to create a more complex set of transactions to comply with local regulations.

Model B presents the additional difficulty that it can be unfriendly to smaller merchants. For example, sole proprietors in France are required to report the full $100 of the transaction as income, increasing their tax liability.

Model A might be a better choice over Model B in that it is friendlier to merchants. However, it exposes your fee structure to your buyers, which may or may not be desirable.

Conclusion

Ultimately you will need to look closely at the details of your own situation to decide which trade offs are better for your business needs. But there’s no need to lock yourself into a particular invoicing model—you can dynamically determine which is better on a transaction-by-transaction basis. For example you could choose to default to Model A or Model B, and switch to Model C for merchants who have established trust with you.