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, agreed upon price are generally (should be!), and po number are 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 specific payment terms (ie. Net 30).
Both the purchase order and the invoice contain similar details. The invoice generally references the purchase order number, along with an invoice number, 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.
David 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 and 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 with a delivery date and an invoice is sent back to David the purchaser.
The invoice confirms the payment was received, or alternatively, the due date of the payment. David then checks the invoice, the purchase order and the packing slip to ensure that all three match.
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 vendors. 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 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 document and concrete instructions for the vendor, as well as a concrete audit 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. It’s often hard to spot duplicate requests, purchases, invoices, or missing 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.
Using an e-procurement software/purchasing system such as Procurify will digitize your entire procurement process (ie. electronic purchase orders) is a great solution to this problem. By having all of your important documents tracked in one centralized system, it’ll be easier for your purchasing department and accounts payable department.
How Do I Integrate Purchase Orders Into My Business?
You’re going to have to take a step back and observe how current business practice handles purchasing and, subsequently, envision how you’d like to control what employees can buy and how they process these purchase transactions.
Integrating Requisitions and Purchase Orders
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 software/purchasing system will allow for efficient purchasing, control, and visibility into your company’s spending.
Requisitions are a purchase order request 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 purchase order requests 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 purchase order request has been submitted.
You will need to create a standardized purchase requisition document, which all employees must then use. That standardized procedure ensures that receiving requisitions does not waste your employee’s time.
As employees begin to draft purchase 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 purchase requisitions that are not immediately necessary.
Once employees begin submitting purchase requisitions, the approver can 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, the purchaser will complete a purchase order and send it off to the vendor. The vendor, 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 Purchase Orders 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.