Invoicing

What Is a Purchase Order? Everything You Need to Know

When it comes to business operations, the creation of purchase orders isn’t usually a business owner’s favorite. However, tracking inventory and buying supplies are critical to business success, which means purchase orders are critical to business success. Relying on purchase orders for the ordering of supplies helps you avoid errors that may occur when you depend on verbal agreements and provides sufficient documentation for financial audits or other issues that may arise.

Though their importance is obvious, some business owners find purchase orders to be a burden in that they take up time and resources that could be used elsewhere. But having a streamlined process can alleviate the time spent preparing purchase orders and even provide valuable insight to improve your bottom line. Below, we provide in-depth information about purchase orders to help you streamline your own process, affording you more time to spend on other business operations.

What Is a Purchase Order?

businesswoman creating a purchase order

A purchase order (PO) is a legally binding document between a buyer and a seller. The buyer creates the PO, then provides it to the seller. The document specifies the products, quantity, delivery location, and other details about the order. The intention of a PO is to ensure there’s no confusion in what the buyer is requesting from the seller. It also provides an official record protecting both parties from problems that may arise (i.e. payment or delivery issues).

How Do Purchase Orders Work?

Generally, businesses use purchase orders to commission inventory or supplies in large quantities. You create this document by providing the details of the order, including quantity, price point, shipping destination, and other information relevant to the request. The supplier receives it, then reviews it to ensure they have the inventory to fill the order. If so, the supplier accepts the PO invoice, fulfills the order, and delivers the products by the specified date. At this point, the supplier sends a bill or invoice. The buyer settles this through the supplier’s POS system, after which the supplier processes the invoice.

Businesses with recurring, large, or otherwise specialty purchases may use a standing purchase order. More information about the different types is below.

Is a purchase order a contract?

Yes. It’s a legally binding contract outlining the buyer’s intention to pay for the number of items at a specified price. Also, they protect the buyer in the event that they’re provided the wrong product or quantity of products, as well as if they’re charged for a different amount than stated.

Purchase Order Types

The best purchase order document to use varies on the type of purchase about which you’re communicating. Below are five that your business may need.

Standard PO

The most common type is the standard purchase order. Typically used for one-off purchases, it includes information such as the items purchased, quantity, terms of payment, and delivery date.

Blanket PO

A blanket purchase order combines several potential orders into one large order. Items ordered through this method generally have a negotiated discount price. It lists the products and quantity, but it may or may not list the pricing. If a blanket purchase order does include pricing, it may outline the price before discount, percentage of discount, and discounted total price.

Digital PO

Technology makes it easier than ever to set up purchase orders. Digitalization streamlines the procurement process for both buyers and sellers. Many popular software programs offer preexisting templates you can use to create digital purchase orders. You can also find templates online.

Planned PO

When a buyer estimates the business’ future product needs, they use a planned purchase order. In this case, you usually estimate the quantity or list a tentative delivery date. The buyer then creates a standard purchase order once the quantity, delivery date, or other unknown variable is determined.

Contract PO

The most formal, offering the most legal protection, is the contract purchase order. In this case, the buyer and seller agree to terms and conditions, but the items, quantities, and other details are defined at a later date. The contract PO acts more like a binding agreement stating that the buyer will purchase from the seller. During the contract period, the buyer sends the seller standard purchase orders for each purchase.

Purchase Order vs Invoice

women with delivery box logging what is a purchase order on computer

While purchase orders and invoices are both inventory management documents, that’s where their similarities end. The buyer creates a purchase order to request goods or services rendered. Meanwhile, the seller creates an invoice as either a request for payment or a receipt of payment after they’ve delivered products to the buyer. On their end, the seller may record this invoice with their invoice reconciliation system. For the buyer’s and seller’s records, the invoice usually references the PO number.

Essentially, purchase orders initiate a transaction, while invoices conclude a transaction.

Sales Order vs Purchase Order

While the buyer issues a purchase order to the seller, the seller issues a sales order to the buyer. A sales order is typically issued after the buyer has remitted payment, but it can also be used for products bought on credit.

Purchase Requisition vs Purchase Order

A purchase order is an external document sent from one business to another. On the other hand, a purchase requisition is an internal document through which an employee seeks approval for a purchase. Depending on the business operation, you may complete a purchase requisition before every order or just those exceeding a set quantity or cost.

What Is Purchase Order Management?

After a purchase is fulfilled, the importance of a purchase order doesn’t end. Businesses use PO systems to track and manage their supply chain. If you’re using digital purchase orders, the software can generate, track, and manage your system. Such software can also be programmed to flag any incomplete documents missing essential information. Digitalization streamlines the processes by screening for any errors that may cause friction in the buyer and seller’s communication.

Pros and Cons of Using Purchase Orders

As with most choices in business operations, there are benefits and drawbacks to implementing a purchase order system. The pros and cons are listed below.

Pros

  • Prevent duplicate orders
  • Limit human errors
  • Track incoming orders
  • Monitor pricing changes
  • Improve budget and inventory accuracy
  • Satisfy auditing requirements
  • Ensure clean communication with vendors
  • Acts as legally binding document protecting both parties

Cons

  • Time-consuming paperwork
  • Ineffective for purchases without a predetermined price or quantity including recurring utility bills, monthly subscriptions, services with varying costs (i.e. advertising and legal), and internal expenses like an employee’s milage reimbursements
  • Credit cards can replace purchase orders in terms of recording and documenting purchases

Purchase Order Process: The 6 Step Procedure

If you’re interested in implementing a PO system, below walks through the six essential steps of the process.

1. Create a PO

The buyer decides to buy a product or service. They create a purchase order detailing the items or services purchased, quantity, terms of payment, delivery location and date, and other necessary information.

2. Get PO approved

Depending on the approval process, the PO may need to be sent to different parties in different departments before it’s sent to the supplier. At this point, you might utilize a purchase requisition.

3. Send PO to vendor

After internal approval, the buyer sends the PO to the seller for review. After receiving the PO, the seller confirms they can fulfill the order. This is the point at which a PO becomes a binding contract.

4. Product or service is fulfilled

When the buyer receives the product or service, the PO has been fulfilled. Generally, the seller includes the PO number on the packing list to help the buyer determine which order they’ve received.

5. Receive an invoice from a vendor

The seller may include a sales invoice in the fulfillment or after the fact. Like the packing slip, the sales invoice references the PO number. This way, the buyer can determine the order for which they’re being invoiced.

6. Send payment

The buyer sends payment for the purchase to the seller, at which point the transaction cycle concludes.

Purchase Order Example: What Does a PO Look Like?

female entrepreneur logging delivery with PO meaning

If you’d like to use a template, there are a few listed below.

What information should be on a purchase order?

The objective of a PO is to provide the buyer and seller with the necessary information. This ensures clear communication and proper execution of the purchase. Below are details that a PO should include.

  • PO number
  • Buyer’s contact information
  • Seller’s contact information
  • Payment terms
  • Shipping method, date, and terms
  • Description of goods or services
  • Quantity (if applicable)
  • Price per unit
  • Total excluding taxes
  • Appropriate taxes (if applicable)
  • Total net

How to Create a Purchase Order

You can create a PO with the aid of online templates or software. You can also create a PO using Microsoft Word or Excel or other similar programs. If you create your own PO to best meet the needs of your specific business, consider including the items below.

  • Date of issue
  • Product details (SKU numbers, brand names, model numbers)
  • Product quantity
  • Price of product per unit
  • Delivery date
  • PO number
  • Terms of payment
  • Your business details including shipping/billing address, contact information, and name

How to Automate the PO Process

Larger businesses may consider fully automating the PO process. If you fall into this boat, ask yourself the following questions in order to find the best software for your business needs.

  • What are the type of forms I need?
  • What are the steps to process the document from end to end?
  • Who on my team needs access to this workflow and what are their responsibilities?

Final Thoughts

A properly executed PO offers clear communication between parties, an audit trail, and a binding agreement all in one document. However, some businesses avoid implementing a PO system due to its draining of time and other valuable resources. Despite these drawbacks, using a PO system opens up a business to many benefits that may have a positive impact on its bottom line.