What are purchase orders? Why are they important? How do I use them effectively?
Great questions, all. And on a critical topic – purchase orders (and their effective usage) is a vital component to any successful business. As such, 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 officers.
What are purchase orders?
Purchase 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 laid out in the document within purchase orders – the more specific the order, the more details that will be included in the purchase order.
When a seller accepts the purchase order, a legally binding contract is formed between the two parties. The buyer is able to clearly and explicitly communicate their requests to the seller so no confusion is created when the purchase order is received.
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.
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. Finally, buyers are provided an invoice, in lieu of that payment.
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. The main (and only) difference between the two is the technical details found on the purchase order are not included on the invoice.
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 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 invoice confirms the payment was received. 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 forego purchase orders in favour of speed, 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 and companies develop a relationship with sellers. Once a company grows and its purchasing demands become more specific, 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 goods and they are not up to specification and 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 will provide legal clarity and concrete instructions for the seller.
Why are manual procedures inefficient?
If your organization is currently using a paper-based procurement process, you are likely creating a lot of 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 and invoices. That’s a lot of documents to produce – and keep track of – for a single purchase.
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. Below we outline the way that Procurify handles purchase orders.
Integrating Requisitions and PO’s
Assuming your organization doesn’t create purchase orders, it is also likely that you’re not managing the requests your employees make when they want to purchase something. This method will allow for the most control and visibility into where your employees are spending the company’s money.
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.
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.
Once employees begin submitting requisitions, the approver can identify purchasing patterns more easily. 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, as 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 the organization, the next step would be 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, as it will help both parties significantly.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 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.
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.
What do PO’s look like?
Purchase orders are, typically, a fairly standard document. They generally contain company information and shipping details, vendor information, and order information with product, price and quantity, as well as additional details to the vendor. Many companies have a standardized purchase order document, which is filled out by employees.
Within 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 procedure.
Hopefully this provided a clear understanding of how purchase order processes are integrated into businesses of all sizes. If you have any questions regarding purchase orders or Procurify, do not hesitate to contact us.
For more information on PO related processes, take a look at these other blog posts:
Why Increasing your first time match rate is critical to reducing costs
Key performance indicators in the Procure to Pay cycle