A purchase order, or PO, is like a love letter to your supplier saying, “I want you and all the goods and services you offer for an agreed-upon price.”
What is a purchase order?
A purchase order is a legal document sent from a buyer to a seller, indicating the type, quantity, shipping terms, and agreed price for goods or services that the seller will provide to the buyer. It is usually used in business-to-business transactions between companies.
A purchase order consists of two activities – an offer from the buyer and an acceptance from the supplier.
The purchase order serves as an offer to buy, and when accepted by the supplier, it becomes a binding contract between both parties. The vendor acknowledges the purchase order by issuing an order acknowledgment and additional information like tracking information.
A purchase order number is assigned to each purchase order and is used to track the transaction. A purchase order is a key part of a company’s procurement process.
Are there different types of purchase orders?
There are 2 types of purchase orders.
A standard purchase order is issued for a product or service.
The second type of type purchase order is called a Blanket order.
Both purchase order types issue the same legal protection to buyers and sellers.
- A standard purchase order is issued when the buyer or a business owner knows what needs to be purchased. For example – I need to purchase a laptop for $1000 each.
- A blanket purchase order is used when the exact quantity is not known. For example – you hired a developer to optimize your website. You agreed to a $100/hr rate, but you don’t know how many hours the developer will consume. So a buyer requests a blanket order to get approvals from procurement, finance, and other stakeholders.
- Sometimes a blanket purchase order can be just an internal document meant only for getting purchase approvals.
What is the goal of a purchase order?
Companies use purchase orders becuase of the following:
- It offers legal protection to both buyer and seller. It is an official document that covers the terms of the purchase. That way, there is no confusion about what needs to be delivered and on what terms.
- It provides better cash flow visibility to the finance team. A PO is issued before the invoice is received by the accounts payable team.
- It helps prevent credit card bills surprise. The teams know what is ordered and whether it is in the budget.
- It helps to streamline work across all departments. For example, the inventory management department would know when to expect the goods as per the PO required date.
What is a purchase order process?
A company follows a purchase order process to issue a purchase order to the supplier.
A purchase order process consists of the following activities:
- A buyer requests a purchase using a purchase requisition form.
- The purchase order request is routed for approval to internal stakeholders and finance departments.
- The purchasing department then issues the purchase order using the standard purchase order template.
- The buyer mentions the standard terms of purchase (item description, price, shipping details)or refers to a contract for specific terms.
- The procurement buyer then dispatches the purchase order to the supplier/seller.
What is a purchase order number?
A purchase order number is a unique identifier assigned to each purchase order.
- A buyer issues a purchase order number. The system automatically generates the purchase order number if you have an electronic purchase order process.
- A purchase order can be a just series, or it could be an intelligent number. An example of a sequential purchase order number is 1000012. An example of an intelligent purchase order number is BU1-JAN-1002, where BU1 represents this purchasing business unit, followed by the month and a sequential number.
- A purchase order provides a unique transaction number that the buyer can use to track the product or service delivery.
Who creates a purchase order in a company?
It depends on the size of the company and the purchasing process of the company.
The buyer typically creates a purchase order using a purchasing system or a manual approach like a word PO template.
- If you are a small company, the accounting team is likely issuing the purchase order.
- If you have a procurement team, the buyer issues a purchase order to the supplier.
- It is not uncommon to have the operations team issue the purchase order to the supplier. For example, in a manufacturing setup, the operations team creates and issues the purchase order to the supplier.
Who issues a purchase order?
A buyer issues the purchase order to the supplier. There are two things to consider here, who issues it and how the purchase order is issued to the supplier.
- A buyer varies from company to company. Large companies have procurement teams that have buyers for each category. They use a standard purchase order form to issue the purchase order.
- In a small company, the buyer could be anyone. For example – the owner of a 10 people company is a buyer when they issue a purchase order. The accounting team could be the buyer because they manage the purchase process.
Now how you issue the purchase order could vary based on the maturity of the purchasing process:
- If you have a manual process, you probably use a spreadsheet or word document to create a purchase order. The purchase order is then emailed to the supplier manually.
- If you use an automated purchasing system like ProcureDesk, the system generates the purchase order and sends it to the supplier.
Who usually signs a purchase order?
It depends on the size of the company. In a small company, the owner signs everything, and in a large company, each department head might sign the purchase order.
The purpose of signing the purchase order is for the buyer to authorize the purchase and for the supplier to verify that an authorized person indeed issues the purchase.
- You can physically sign the purchase order or use an electronic signature.
- A purchasing system eliminates the need for signing the purchase order because the approvals are maintained electronically.
A purchasing policy specifies who can sign a purchase order or authorize a contract purchase. If you don’t have a purchasing policy, click here to download it.
What are the advantages of a purchase order?
A purchase order provides certainty and visibility across the organization. Here are some of the advantages of a purchase order:
- It avoids confusion between a buyer and supplier because the purchase order document lists what is being purchased and under what terms.
- A purchase order provides better cash flow visibility to the finance team. The finance team can review the purchase request to ensure that there is a budget for the purchase.
- It helps increase team collaboration because everyone can refer to a single document. For example – the inventory department, warehouse department, and procurement team.
- A purchase order process streamlines purchasing across the company.
What are the disadvantages of a purchase order?
Although a purchase order process has many advantages, here are some of the disadvantages:
- It makes the purchasing process long because a purchase order needs to be issued before making the purchase.
- If you don’t have an automated purchasing system, it can take a lot of effort to create the purchase order, email it to the vendor, and so on.
- If the vendor doesn’t provide the acknowledgment of the order, it could lead to delays. The buyer sends the purchase order, but the seller never confirms that they received the purchase order.
- A purchase order is legally binding, so if either party doesn’t pay attention to the terms, it could lead to confusion and sometimes litigation.
What is a blanket purchase order?
A blanket purchase order is a type of purchase order that allows a buyer to place an order for goods or services from a seller without specifying the exact quantity or delivery date.
This type of purchase order is often used when the buyer needs to make multiple orders over some time but does not want to have to create and submit separate purchase orders for each transaction. The blanket purchase order outlines the general terms and conditions of the agreement, such as payment terms, delivery dates, and pricing information.
Is the purchase order a contract?
A contract needs an offer and acceptance. A purchase order becomes a legally binding document between a buyer and seller when the seller accepts the purchase order and its terms. So yes, you can consider a purchase order a contract.
A purchase order mentions not only commercial terms but also mentions legal terms. Many companies print all their terms on the purchase order.
The purchase order outlines the details of the transaction, such as quantity, price, delivery date, payment terms, and other important information. Once both parties accept, it becomes a legally binding agreement that both must adhere to.
In most cases, an order acknowledgment is considered an acceptance from the supplier that they accept the purchase order and its terms.
What is the difference between a purchase order and an invoice?
This is how a purchase order is different from an invoice:
- A purchase order is issued by the buyer to the seller, while an invoice is issued from a seller to the buyer.
- A purchase order is issued first, and then an invoice is issued against that purchase order. A vendor often issues an issue without an associated purchase order number.
- A purchase order is a request from the buyer to the seller to ship products or perform certain services. On the other hand, the invoice is a request from the seller to the buyer for the payment of the said products or services.
- A buyer issues the purchase order within a company while an invoice is processed by the accounts payable department of a company.
- A purchase order should always be sent for approval before issuing to the vendor. The vendor invoice needs to be matched to the PO and only sent for approval in case of an exception.
- A purchase order mentions the shipping address, and shipping method, while an invoice mentions the payment instructions from the seller to the buyer.
Do you need a PO before an invoice?
The best practice is to have a purchase order (PO) before an invoice.
Here is why:
- When you issue a purchase order, management reviews the purchase and ensures that you have the budget available. If the budget is not available, you can decline the purchase.
- If the invoice shows up before the purchase order, the purchase is already made, and the company is obligated to pay the supplier, whether they have the budget or not.
- When the purchase order is issued in advance, the supplier knows the terms of the purchase, which avoids confusion on commercial terms like payment terms. For example, the buyer always pays Net 30, but the supplier expects payment on receipt of the invoice.
- If the purchase order is issued before the invoice, the accounts payable department matches the invoice with the purchase order and receipt to perform a 3-way match. If the 3-way match is successful, you don’t need additional approvals to pay the invoice.
- You might not need a purchase order for a one-off purchase or services like legal services.
Is the purchase order legally binding?
Yes, a purchase order is a legally binding document between the buyer and seller.
In legal terms, for anything to be legally binding, you need two parties, and you need an acceptance and offer.
- In the case of a purchase order, the two parties are the buyer and the seller.
- When the buyer issues the purchase order to the seller, it is called an offer. It is acceptable when the seller confirms that it can ship the product or performs the service per the mentioned terms.
So the purchase order is legally binding only if the supplier accepts the purchase order. When you have a purchase order system like ProcureDesk, it automatically asks the vendor for order acknowledgment and acceptance.
How Does a Purchase Order Work?
A purchase order process enables a company to streamline the purchasing process. The purchase order provides a process for the entire company to follow.
Each company might have its process, but here are the key steps that you must have for a purchase order process to work:
The process to approve the purchase
Every company needs a process to approve the purchase before issuing a purchase order to the supplier.
- A purchase request is entered by the employee and sent to the finance department for approval. For example, an employee wants to purchase 100 widgets from a supplier at $100 each.
- The finance department checks for budgets and approves or rejects the purchase request.
- The purchase request is sent to accounting or the procurement department for further processing.
Dispatch the purchase order to supplier
- The purchase order is created using a template or automatically generated by a purchase order system.
- The purchase order is emailed to the supplier or automatically dispatched using a purchase order system.
- The vendor confirms that they have received the purchase order and acknowledges or rejects the purchase order terms.
- The vendor provides a tracking number once the vendor ships the product to the buyer.
- The buyer then tracks the purchase order for delivery.
- Once the purchase order is delivered, a purchase order receipt is created to confirm the quantity received.
What is a purchase order example?
Below is an example of a purchase order:
A purchase order has the following elements:
- The purchase header lists the vendor information, the shipping address where the product needs to be shipped, and the Bill to information.
- The buyer provides the Ship to and Bill to information to the seller. The supplier uses the Bill to provide information to send the invoice, and the ship-to address is where to send the purchased products.
- There is additional information like Payment terms and the order contact details so that the supplier can reach out in case of any questions.
- The line item details cover the details of what is being purchased. That includes Item number, Supplier item number, Item Description, Quantity purchased, and Unit price.
- It is optional to add additional information like taxes and shipping.
- In the end, you provide a summary of the purchase and add an authorized signatory to the purchase order. This is proof for the vendor that the purchase order is authorized at the correct authority level within the company.
How Do I Get Started With the Purchase Order Process Today?
The simplest way to start with a purchase order process is to define the steps that you need in a purchase order process. We listed some of the steps above in the “how does a purchase order work” section.
Use that as guidelines to establish your process and tweak the process based on the feedback of your employees.
PS- At ProcureDesk, we help companies like yours to implement and automate the purchase order process. Schedule a demo with one of our product specialists and see how easily you can automate your purchasing.