Purchasing the right items in the right quantities is essential to the smooth running of your business. To aid this task, it’s essential to issue a purchase order whenever you’re buying goods or services from a supplier. But what is a purchase order exactly?
A purchase order, commonly referred to as a PO, is an official document that a buyer issues to a seller confirming intent to purchase goods or services from the seller. It lists the items the buyer wants to procure, quantities, payment terms, and delivery details.
How Do Purchase Orders Work?
A purchase order isn’t just a piece of paper. If the seller accepts it, it becomes a legally binding contract obliging the buyer to pay for goods or services received. This protects both parties’ interests. That’s why buyers use purchase orders for most transactions, particularly those involving large or high-value items.
For procurement departments, purchase orders are especially beneficial for supply chain management because they help businesses evaluate supplier performance, manage spending, and track and optimize inventory levels.
Benefits of Purchase Order
Purchase orders offer businesses several benefits, including:
Preventing Duplicate Orders
Duplicate orders occur when businesses mistakenly order the same item more than once. If duplicate orders aren’t detected, they can lead to costly duplicate payments.
POs can help prevent duplicate payments through three-way matching, which involves comparing POs against order receipts and supplier invoices before making payments.
Tracking Orders
Monitoring multiple orders from many suppliers can be challenging. POs help businesses monitor inbound orders and inventory, enabling buyers to optimize inventory levels and prevent stockouts or overstocks.
Serving as Legal Documents
A PO serves as a legally binding contract once a seller accepts it. Since it’s legally enforceable, it protects the buyer and seller if there’s a dispute over the transaction.
Yet, despite these benefits, purchase orders have some downsides. Preparing them can be time-consuming, particularly when using manual processes. Creating them can also be costly because they introduce additional labor and paperwork processing costs.
Lastly, creating POs is often impractical for small purchases because they don’t increase the value of the items bought.
Purchase Order vs. Invoice
Purchase orders and invoices are legally binding commercial documents used in transactions between buyers and sellers. While they share this similarity, there are several distinctions between the two documents.
- Purpose: A PO is issued by the buyer to the seller to request goods or services. In contrast, an invoice is issued by the seller to the buyer to request payment for goods or services that have been delivered.
- Timing: A PO is created before the purchase, while an invoice is generated after the goods or services are delivered.
- Content: A PO contains order details like the items requested, quantities, payment terms, product prices, and delivery details. An invoice typically includes the same information, as well as an invoice number and payment due date.
A purchase order also isn’t the same as a purchase order request. A purchase order request is an internal document that an authorized employee creates to obtain approval from management to procure goods or services.
Types of Purchase Orders
There’s no one-size-fits-all purchase order for all transactions. There are various types of POs for different situations.
Standard Purchase Orders (PO)
Standard purchase orders (POs) are the most common type of PO. These POs are primarily used for one-off transactions with clear purchase order requirements. They include all key order details such as item type and quantity, pricing, payment terms, and delivery dates.
Planned Purchase Orders (PPO)
Planned purchase orders (PPOs) are similar to standard POs, but with a notable exception: PPOs omit exact delivery dates. They are primarily used by businesses with recurrent orders that wish to maintain flexibility.
Blanket Purchase Orders (BPO)
A blanket purchase order (BPO), or a standing purchase order, is a long-term agreement between a buyer and supplier that allows the buyer to order specific items many times over a particular period without issuing a new PO for every individual purchase.
BPOs are ideal for indirect procurement of recurring purchases like office supplies and software licenses.
Contract Purchase Orders (CPO)
A contract purchase order (CPO) is a long-term agreement between a buyer and seller that outlines the terms and conditions for future purchases. While it’s somewhat similar to a BPO, a CPO doesn’t specify exact items, quantities, or prices. It’s mostly used by businesses looking to lock in favorable payment terms with suppliers over a long period.
Digital Purchase Order (DPO)
Digital purchase orders, also called electronic purchase orders, are digitally created and managed within e-procurement or enterprise resource planning (ERP) systems.
Manually created purchase orders are prone to errors. DPOs eliminate the need for paper-based POs, enhancing accuracy and promoting consistent order fulfillment. They are ideal for businesses looking to automate their procurement workflows — freeing team members to focus on high-value tasks.
How To Create a Purchase Order
Procurement teams typically use purchase order software or templates to create POs. While formats vary, most purchase orders need to include these details:
- PO number
- Items required and quantities
- Customer and supplier company name and contact details
- PO issue and delivery date
- Product details such as the SKU and model numbers
- Shipping address
- Billing address
- Payment terms
- Order total
How Do Suppliers Use Purchase Orders?
While purchase orders are issued by buyers to suppliers, POs also help suppliers immensely. POs are legally binding documents between buyers and suppliers, making them essential when disputes arise. POs also create an audit trail of all purchases, helping suppliers keep records for financial audits, tax purposes, or to comply with federal acquisition regulations.
Additionally, POs help suppliers with package management since they list precisely what buyers want, including item descriptions, prices, and delivery dates. Certain purchase orders, such as BPOs, also help with demand forecasting, enabling suppliers to manage stock effectively.
For suppliers seeking to reap the benefits of using POs, here are some best practices to keep in mind:
- Automate systems: Use an e-procurement or ERP system to monitor incoming POs in a single location.
- Verify orders: Compare purchase orders against invoices and receipts to prevent discrepancies and potential conflicts with buyers.
- Acknowledge POs: Promptly confirm PO receipt to give buyers peace of mind and build trust.
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