How Do Purchase Orders Work?
A purchase order is a document that goes from a purchaser to a supplier to confirm the purchase of goods or services. This one little document plays a major role in how things operate within a growing business. Relying on purchase orders helps to clear up a lot of potential logistical confusion.
A purchase order is not an invoice. It is issued by the buyer who uses it to make sure they get exactly what they ordered. Invoices are issued by a vendor who wants to make sure they get paid for said purchase.
Purchase orders outline exactly what the order should contain and when it should arrive. It includes things like the quantity of items, a detailed description of the items, the price, date of purchase, and payment terms.
Vendors only send invoices after they have approved the purchase. When invoicing, the vendor typically includes the purchase order number or PO number so that the financing Department can match the information on both forms.
Purchase Orders vs. Sales Orders
The purchase order officially confirms purchases and are sent from the buyer to the vendor. A sales order on the other hand is sent by the vendor to the purchaser to confirm a sale before the order is fulfilled.
Elements of a Purchase Order
- PO Number – Assigned to the order by the purchasing system, used on the invoice and goods receipt for three-way matching
- Purchase Order Date – the date you submitted the order to the vendor
- Vendor Name and Billing Address – the company you’re purchasing from and the address where you’re sending the purchase order and payment
- Buyer’s name and shipping address (this is your company and where you want the product delivered)
- Additional contact information, including phone numbers and email addresses
- Delivery date – the expected delivery date for the items in the purchase order
- Shipping method
- Shipping terms
- Item names and descriptions, including any technical information like model numbers, SKU, colors, etc.
- Item quantities
- Item unit costs
- Line total
- Total price, with pricing discounts based on the agreed price
- Payment terms – Net 30, 60, 90, COD, credit card, etc.
There are a number of purchase order templates and forms you can use. What matters is that you have the order details, due dates, and payment terms on the document.
Purchase orders are standardized throughout the entire company. At the least, they contain information about the purchaser and the vendor along with the order itself and the payment terms. Today, most companies use an electronic purchase order system that is managed with accounting software.
Why Businesses Use Purchase Orders
When a business is in the start-up stage, they typically forego using a purchase order process for something more informal. This approach is often quicker and saves time and money when the company is strapped for cash.
But, as the company grows and their purchasing becomes more detailed, complex, and urgent, relying on a cash for goods purchasing system in an Excel spreadsheet does lead to confusion. It may lead to duplicate orders, fraudulent transactions, and ultimately cost more money in the long run.
Let’s say your company orders 15 laptops from a vendor, paid for them, and only 10 laptops arrive on delivery day. If you and the vendor can’t come to an agreement, and there’s no purchase order, you’re in a tough spot. The purchase order is a binding contract and serves as the paper trail you need as proof of your original order of 15 laptops. Without it, it will be difficult to prove your case, and you may be out that extra money – and the laptops. In other words, having a purchase order can protect your small business.
It’s not enough to send the purchase order to the vendor for it to become legally binding – it has to be signed (or otherwise acknowledged by the vendor before it’s considered a legal document.)
Once the vendor approves the purchase order, you’re both legally bound to your end of the deal. So if you have a purchase order the vendor agreed to and you don’t pay, even though the vendor sent everything on the order, you could end up in court.
Easy to Track Orders
Purchase orders make it simpler to account for all the goods and services your company orders, as well as how you’re paying for them, and when you can expert them. It’s a great way for business owners to handle record keeping.
The same way invoice numbers help you to manage your purchase orders, you can use PO numbers to track all the orders you’ve sent. It helps with operations and accounting. Operations knows your suppliers are contractually obligated to deliver goods or services by the date on the order. This helps with inventory management. Accounting can more effectively handle budgeting knowing the purchase price is bound by the contract.
Better Audit Protection
If you’re ever audited, you’ll have a strong paper trail to support your transactions. Electronic systems even create an audit trail to see who took what action and when. It’ll make it easier to cross-check your invoices and packing slips, too. If you don’t have purchase orders, you’ll spend countless hours looking over invoices, receipts, and email threads with vendors.
SImplifies Things for Your Vendors
Chances are your vendor is fairly used to getting purchase orders for most of, if not all of their incoming orders. Sending one may actually help you get your shipment faster. Why? Because everything they need to know is in one place. That makes everything straightforward and keeps them from having to back and forth with you – which opens the door to plenty of miscommunication.
If you have lots of vendors or a lot of purchases from a few vendors, purchase orders are a necessity. It’s a simple process that can save a lot of time and money.
How Purchase Orders Work
The process of working with purchase orders may be a bit complicated, depending on how your business or industry operates. Here’s a quick overview, from the purchaser’s perspective:
First, management notifies the purchasing department or procurement staff that a purchase is required. Some companies complete this step by first issuing a purchase requisition form.
If the purchasing department approves the request, they fill out a purchase order with the details of exactly what the purchase is. If there are a lot of purchases from the same vendor over a period of time, it may be easier to issue a blanket purchase order, which covers a specific period of time, or dollar amount.
That purchase order then gets sent to the vendor who decides whether they can and want to fulfill the order. After they approve the purchase order, it becomes a legally binding document.
At that point, the purchaser sends payment for the agreed-upon price or sends payment at the later date specified on the purchase order.
The vendor then delivers the order along with an invoice. The finance department compares the invoice to the purchase order to make sure the two documents match. If any issues or discrepancies arise, they can contact the vendor to sort them out.
An electronic purchase order system with three-way matching like PLANERGY, automatically compares the purchase order to the invoice and the goods receipt to make sure that everything matches. If there’s ever anything wrong – such as goods that are billed but not received, goods billed that weren’t ordered, etc. the invoice is flagged in the procurement system for manual intervention.
Is There Ever a Time When You Don’t Need a Purchase Order?
Making an important or large purchase without a purchase order is generally a bad idea. However, there are some situations where they may or may not be required according to company procurement policy and purchasing process.
For example, certain regular and recurring purchases that relate to the day-to-day operations of your business such as Utility payments, monthly subscriptions, and memberships are usually billed every month and therefore do not require a purchase order.
Internal expense reimbursements for things like educational materials, entertainment, supplies, and travel are usually tracked on their own separately, and rather than a purchase order require a reimbursement request.
You have to know the total cost of a purchase beforehand to fill out a purchase order. As such, costs that have an unknown future total such as legal expenses or advertising cost for instance cannot be purchased with a purchase order. You can use an invoice for these.
To keep things efficient and simple, businesses often set a lower-cost threshold for issuing a purchase order. For instance, your business may decide that it is most efficient if any order smaller than $500 doesn’t use a purchase order. For some companies, that number may be higher.