A purchase order is a commercial document issued by a buyer to a seller authorizing the purchase of specific goods or services, and it can be used as a legally binding agreement to ensure the terms of a transaction are met and provide a detailed record for auditing and financial management.
Like an online shopping cart, a PO aids both parties in recording transactions and outlining order specifics, payment terms, and delivery details.
The main things to include in a purchase order are:
- PO Number: A unique number for identifying the order.
- Purchase Order Date: When the order was made.
- Buyer and Supplier Details: Information about the person or business buying the goods or services and the supplier details.
- List of Products/Services: A detailed list of what’s being bought, including the quantity, SKUs, individual price, and total cost.
- Delivery Information: Where the goods should be delivered, and by what date.
- Payment Terms: When and how the buyer will pay the seller.
- Approval: The signature or approval from someone with the proper authority in the buying organization.
Pros and Cons of a Purchase Order
Below you can find the advantages and disadvantages of purchase orders:
Advantages of Using a Purchase Order
- Creates a detailed list of what is being ordered.
- It helps you track the purchase through your system to manage your payables.
- Develops transparency to budget more effectively and plan invoicing and cash flow.
- Creates a binding contract between you and the vendor.
Disadvantages of Using a Purchase Order
- Creates additional documentation and steps to the purchasing process, which may create more work for your staff.
- Credit cards can replace purchase orders to help with record keeping and purchase documentation, although they don’t act as a legal contract between the supplier and the vendor.
Purchase Order vs. Invoice
A Buyer sends a Purchase Order BEFORE payment is made to request the Seller deliver a certain number of goods officially. In contrast, a Seller sends an invoice AFTER placing an order and demands payment for the goods purchased.
Alternatively, an Invoice is used as a receipt when the Buyer has paid for the goods ordered.
Purchase Order Process
Below are the steps for creating and using purchase orders in your business.
Step 1 – Request Purchase Approval
This first step depends on the company’s size and structure. In some businesses, departments or managers need approval from another department, like accounting or finance, before purchasing.
This step allows the company to maintain some control and budgetary discretion over purchases.
Step 2 – Create and Approve the Purchase Order
Once you receive approval, it’s time to create the purchase order. The order should include a detailed list of purchased goods or services. Since the document confirms what you ordered, it’s essential to ensure the list of goods and services is correct before sending it to the vendor.
Use a purchase order template to ensure you include all the essential information.
The purchase order should also include a purchase order number. This will help you track it through the process and the invoicing system.
Step 3 – Send Purchase Order to Vendor
Once the purchase order is ready, please send it to the vendor. This is their indication that you are prepared to purchase their goods or services.
Step 4 – Vendor Acknowledges Receipt
After the vendor receives the purchase order, they should acknowledge the receipt (a bill of sale could be used instead, which can include more purchase details). Once this happens, the purchase is binding.
Barring any extraordinary situations, the vendor owes you the goods and services, and you owe them the money.
Step 5 – Vendor Delivers Goods or Services
At this point, the process is in the vendor’s hands. It is now their job to deliver the goods and services specified in the purchase order. This should happen promptly. If it doesn’t, you may be able to pull the purchase order.
Step 6 – Matching of Documents and Closure of Purchase Order
The final step is to match the goods and services delivered with the purchase order and the invoice. Everything should align to ensure you only pay for your ordered goods and services. If everything is in alignment, it’s time to pay the invoice.
When filling out a Purchase Order, you should keep in mind the following tips:
- Use Modern Technology: Make sure you use a centralized computer system that makes tracking your purchase orders easier.
- Be Fast: You must send your purchase orders and invoices out as early as possible. That way, the other party has plenty of time to respond.
- Use Templates: You should also use a purchase order template to make it easier to distribute purchase orders quickly.
When to Use a Purchase Order
This document is commonly used in business and commercial transactions for more sophisticated transactions. If you are buying many products or types of products, you should use them to document what is being purchased for your business formally.
Because these are legally binding contracts, Buyers can create a formal paper trail of items purchased for their business. Official records help bookkeepers and accountants keep track of inventory, orders placed, and items received.
A PO is a written authorization from a Buyer to acquire many goods or services. The Seller is then legally obligated to deliver such goods and services.
You should use one if one of the following situations apply:
- order a large number of items for business purposes
- manage purchases of a large inventory
- track multiple payments to different vendors
- buy several items from a supplier or other company
- match shipments with purchases for auditing or bookkeeping purposes
- accounts payable department wants to specify the precise terms of goods provided