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 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.
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.
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 are purchase orders 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 acknowledgments, 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. Paperwork 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. Using 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 digitizes the entire procurement process is a great solution to this problem.
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 through an e-procurement system like Procurify, 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 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 catalog 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.
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.