All You Ever Need to Know About Purchase Orders

7

What are purchase orders? Why are they important? How do I use them effectively?

This is a critical topic – purchase orders (or POs) and their effective usage are a vital component to any successful business. This post is intended to provide both a clear explanation of purchase order processes for beginners, as well as highlight tips for improving these processes for seasoned finance or procurement specialists.

So…what are purchase orders?

Purchase Order ExamplePurchase orders are documents sent from a buyer to a supplier with a request for an order. The type of item, the quantity and agreed upon price are generally (should be!) printed on the purchase order – the more specific the order, the more details included, the more effective the purchase order will be.

When a seller (aka, supplier, vendor, etc) accepts a purchase order, a legally binding contract is formed between the two parties. In addition, the buyer should always clearly and explicitly communicate their requests to the seller so there is no confusion when the purchase order is received.

Also, in the event the buyer refuses payment, the seller is protected because the purchase order is a binding contract between both parties.

Lastly, some commercial lenders will use purchase orders as a reference to provide financial assistance to an organization.

First Issue of Procurement Sense Magazine Now Available!

Read about the latest industry trends from 10 thought leaders!

How are purchase orders different from an invoice?

Buyers draft purchase orders. Sellers, on the other hand, prepare invoices, once a payment has been received. In some cases, buyers are provided an invoice, with a payment due date.

Both the purchase order and the invoice contain similar details. The invoice generally references the purchase order number as well, in order to confirm that both documents contain the same information and correspond to each other. The main difference between the two is the technical details found on the purchase order are not included on the invoice.

Example:

John the purchaser has been notified that a department needs a new set of desks. He creates a purchase order with the quantity and specific requirements (size etc.) for the desks.

The company responsible for selling/manufacturing the desks then receives the order. Once they confirm they are able to supply the desks with the required specifications, they approve the PO and take the payment. Once that payment is received, the desks are shipped and an invoice is sent back to John the purchaser.

The invoice confirms the payment was received, or alternatively, the due date of the payment. John then checks the invoice, the purchase order and the shipping slip to ensure that all three match up.

Why is this important to your business?

Many organizations unwisely forego purchase orders because they perceive the paperwork to be a hassle that slows things down, or simply because they already have a working relationship with vendors. When businesses start small they tend to have an organic purchasing process. Over time, however, that process changes as companies develop relationships with their sellers. Once a company grows and the purchasing demands become more specific, urgent, and/or complex, communication challenges can arise if a purchase order isn’t used or certain details are not correct on the order.

If a buyer receives their order and it does not comply with the desired specifications, if there is no purchase order to use as a reference, it can be a nightmare for both parties to determine where the request went wrong. At that point it’s likely that both payment and an invoice was sent, which puts both parties in a significantly more complicated legal situation.

A purchase order provides legal clarity and concrete instructions for the seller, as well as a concrete paper trail that can be used as a point of reference for when things go wrong.

Why are manual procedures inefficient?

If your organization is currently using a paper-based procurement process, you are likely creating excessive documents. Most companies will process up to seven documents during a purchasing cycle. This includes requisitions, purchase orders, quotations, order acknowledgements, advice notes, goods-received notes, packing slips,  and invoices. That’s a lot of documents to produce – and keep track of – for a single purchase.

As much as good record keeping is vital for effective and efficient purchasing and procurement, there are problems with paper based records. Paper work can easily be lost, damaged, or accidentally destroyed. With paper, it’s often hard to spot duplicate requests, purchases, or invoices, or missed transactions – all of which can cost your company time and money. Paper also requires an efficient and regularly updated filing system which consumes space and man hours in order to work effectively. E-procurement software, such as Procurify, which digitalizes the entire procurement process is a great solution to this problem.

Purchase Orders

How do I integrate purchase orders into my business?

You’re going to have to take a step back and observe how your current business handles purchasing and, subsequently, envision how you’d like to control what employees can buy and how they process these transactions.

Integrating requisitions and PO’s

Assuming your organization doesn’t currently use purchase orders, it is also likely that you’re not managing the requests your employees make when they want to purchase something. Using purchase orders, especially though an e-procurement system like Procurify, will allow for the most control and visibility into where your employees are spending the company’s money.

Purchase requisitions

Requisitions are requests your employees make for materials or items they need to do their job. Many organizations simply allow their employees to email a manager their request, and then have that person make the necessary purchases. Adding requisitions creates two important benefits – the ability to manage a budget for employee spending and the opportunity to take advantage of volume discounts on large orders. Most organizations will allocate a budget to a purchase once a requisition has been submitted.

You will need to create a standardized requisition document, which all employees must then use. That standardized procedure ensures that receiving requisitions does not waste your employee’s time. Procurify can automatically create digital requisitions, which can be sent to the appropriate purchaser automatically.

Budgets

As employees begin to draft requisitions, you’ll be able to create an average monthly spend and track what your employees are purchasing. This means you can start analyzing how they use supplies and identify opportunities for savings. An approver will be the person managing the budget. If employees go over budget, the approver may not approve all the requisitions that are not immediately necessary.

Volume discounts

Once employees begin submitting requisitions, the approver can more easily identify purchasing patterns. The approver can then submit bulk orders and request discounts if they are available. If the requests are created digitally, it can significantly reduce processing time because frequently requested items can be added to a catalogue from the best supplier at the best price.

From requisition to purchase order

Once requests have become a standard process in your organization, the next step is to create the purchase order process. This is likely as simple as contacting suppliers and informing them that from now on you’ll be submitting a purchase order before sending payment for goods. The supplier will likely be happy about this because it will significantly help both parties. Once your approver has some requests that need to be fulfilled, they complete a purchase order and send it off to the seller. The seller, if necessary, will communicate any concerns or issues with the purchase, otherwise they will ship the order and invoice once payment is received.

Once your approver has some requests that need to be fulfilled, they complete a purchase order and send it to the seller. The seller, if necessary, will communicate any concerns or issues with the purchase, otherwise they will ship the order and invoice once payment is received.

Integrating both requisitions and purchase orders will significantly increase your ability to track expenses and remove a lot of headaches associated with employee/company purchasing. Visibility in your company’s spending is critical and this process will help you achieve that.

What do PO’s look like?

Purchase orders are, typically, a standard document. They generally contain company information (name etc.) and shipping details (address), vendor information (name and address), order information (product, price and quantity), as well as additional details to the vendor. Many companies have a standardized purchase order document with stock information to ensure consistency.

With Procurify, purchase orders look a little different. Instead of being a standard document, purchase orders are generated after a purchaser has compiled all the required orders for a certain vendor. General ledger codes are assigned to each purchase order, ensuring easy integration into your accounting procedures.

About Author

Kenneth Loi

Kenneth is Chief Operating Officer and Founder of Procurify and oversees several business divisions including Operations, Product Management and Customer Relations. Kenneth's vision is to assemble the dream team to help build an enterprise product that helps solve critical business problems yet intuitively easy to use.

7 Comments

  1. Pingback: Purchase Orders 101

  2. Do purchase orders require terms and conditions? I mean, could someone just write something on a napkin, sign it, and call it a purchase order, and it would be a legally binding contract?

    Not sure if it matters, but I’m in California.

    Thanks!

    • Sean Kolenko

      Hello Cath,

      Thanks for the question.

      A purchase order does need terms – specifically types, quantities, and agreed prices for products or services. What makes a purchase order a legally binding contract is its acceptance by the seller. So, technically speaking, if you included the aforementioned details on a napkin and it was accepted by the seller, it would be good to go.

      With that said, you might have a hard time convincing a seller to accept a purchase order in such a form. Purchasing best practice is to use a standard purchase order form – such as the one electronically generated in Procurify – for all purchases.

      Thanks!

  3. I received a purchase order for two items
    1. The product which is covered for a year of warranty
    2. An AMC for 3 years post warranty period.

    The product was delivered and the warranty period was over. Both parties were expected to sign an AMC contract which did not happen. Now I have payment dispute with the buyer on another PO and therefore want to cut all association with the buyer. Therefore I do not want to enter into the AMC agreement
    My question is that since I have delivered and invoiced for one item in the PO, is it required that I provide the second item? Can I refuse to enter into the AMC agreement and not raise an invoice?

    • Hey Kevin,

      Sorry about the delayed response.

      First off, this should not be taken as legal advice. It’s just my understanding of Purchase Orders.

      Creating a purchase order is really just the first step in the purchase to pay process. The PO protects the seller in case the buyer refuses to pay for goods delivered or services rendered in the future. A purchase order doesn’t bind the vendor to produce a good unless further contracts are signed or other agreements are made.

      A purchase order is an expression of interest from the buyer that they desire a good or service from a particular vendor. The Purchase Order would still need to accepted by the vendor or seller.

      You can refuse to accept purchase orders.

      If you already accepted the terms for the two items then breaking the agreement for the second item may cause problems. You may run into legal issues, with punishments set out in the agreement, usually in the form of a fine.

      Hope this helps.

  4. Pingback: The Microsoft Dynamics GP all-in-one document viewer

  5. Pingback: Stages in the procurement process

Leave a Reply