A purchase order is used to maintain a smooth purchasing process for a business. A properly documented purchase order can help avoid duplicate orders, track incoming orders and keep invoices in check. In this blog post, we’ll go over why a purchase order is so valuable and how it works step by step.
What is a purchase order?
A purchase order (also known as a PO) is a legally binding agreement created by a buyer for a seller. A PO documents what products a buyer wants, how much the products costs, payment details and any delivery stipulations made. Purchase orders also function as a type of insurance for sellers since orders are typically filled before the buyer receives their bill. Additionally, POs help your business stay within budget and control spending.
Benefits of purchase orders
A PO benefits both buyers and sellers. It serves as a centralized hub of information so that any issues relating to the order can be addressed quickly:
Keeps track of incoming orders
An accurately filed purchase order will let you know exactly when an order will be coming in. Companies can avoid hassles with inventory or fulfilling other orders by having information available down to the date of shipment, thereby maximizing efficiency and managing all expectations with convenient tracking.
Avoids duplicate orders
Every PO comes with a unique identification number, so the moment that same number pops up in a system, companies know there's something amiss.
Serves as legal documents
Purchase orders function as legally binding documentation, which helps prevent anyone involved with the order from not fulfilling their end. A PO also provides a paper trail for financial audits that may occur at a later date.
Types of purchase orders
Purchase orders fall into four different categories. Determining which to use will depend on your business functions and needs.
Standard purchase orders
These types of purchase orders are straightforward, tracking only essential information regarding an order. A standard purchase order is typically used for one-time purchases. As mentioned, they detail the products ordered, quantity, price and shipping details.
Planned purchase orders
A planned purchase order functions much like a standard purchase order, but this type contains tentative details between the buyer and the seller, such as the delivery and payment dates. For example, a car shop has a planned purchase order with their seller that lists the price and quantity for car parts of a particular vehicle model they serve throughout the year. The delivery schedule is tentatively listed, however, since they're not exactly sure when each part will be needed. As the year progresses, if the car shop ends up requiring additional quantities, they can order more from the seller via a release against the planned purchase order. This type of PO is an excellent option to cover your bases if you think an order might need some flexibility.
Blanket purchase orders
Blanket purchase orders serve as a long-term contract if a business intends to regularly order the same item from a seller over a period of time. This simplifies planning for both parties so that multiple orders don't have to be created. Building off the car shop example, let's say the business needed more than one kind of part at different stages of the year. Having a blanket purchase order in effect with a seller that details the set price and delivery period would help them streamline their orders and track them as well.
Contract purchase orders
A contract purchase order is used to establish purchasing terms and conditions for the long-term. For example, if a buyer wants to secure a vendor's services, they could place a contract purchase order, establishing price and delivery options but leaving the products to be purchased unspecified. Both parties are still contractually and transactionally involved, they're just waiting for the need for the product to arise.
How purchase orders work
We’ll continue using the car shop example to illustrate how a purchase order works in general. Several different purchase orders can go through all or some of the processes listed below, and the steps may differ depending on the business.
1. Buyer decides to order items from the seller
Step one is relatively straightforward: It’s a simple request for goods or services. The car shop orders several tires for a model that comes to them often.
2. Buyer drafts purchase order and sends to seller for approval
Knowing exactly what they need and how much, the buyer will create a purchase order along with details on when they need the item and what shipping costs might be incurred, then they send it to the seller. At this stage, our car shop would contact a local tire yard and put in a PO for 16 tires by Thursday, offering to pay the freight for the order.
3. Seller reviews purchase order and confirms if they can fulfill the request.
The seller looks to their available inventory and resources to confirm they can meet all the order requirements. If everything is good in that regard, they can proceed. Creating a PO allows them to avoid an order they'd be otherwise unable to fulfill. In the car shop example, the tire yard confirms they have the right number of tires available and can prepare them for shipping to be delivered by Thursday.
4. Purchase order approval
With both parties in agreement over the purchase order details, this step is simply both of them confirming and moving forward with the order. For our car shop, that means they offer a final confirmation with the tire yard who has stated they can meet the demand. Everything gets a green light, and things get moving.
5. Product or service is fulfilled
In the next phase, the order is completed. All products are shipped to their destination in accordance with the agreed upon terms. For our car shop, a successful fulfillment means they receive their 16 tires by Thursday.
6. The invoice is paid
The seller’s generated invoice, created via whichever PO tracking software is in place, would be sent promptly to the buyer in this final phase, at which point the buyer simply pays the regular price of the goods they purchased. At this step, the car shop pays the money they owe for the 16 tires and the costs to ship them.
The difference between purchase orders and invoices
The biggest difference between a purchase order and an invoice is function. Purchase orders are created to track and guide the purchasing process. Invoices, by contrast, are official payment requests made by vendors once the original order has been filled. For a more simplified explanation, think of it like this: A purchase order states the details of an order and is legally binding. An invoice, on the other hand, requests payment. Purchase orders and invoices can be used together as part of a two- or three-way match process to complete a payment.
Automate your purchase order processing with Routable
Manual purchase order processing is time consuming and increases the likelihood of errors. If you're interested in improving your current PO process, automation is the best way to do that. Comprehensive automation software like Routable can help your team cut down on manual data entry to process and track POs more efficiently and accurately. Routable connects to the accounting software you love (Xero, QuickBooks, NetSuite and Sage Intacct) using real-time two way sync for clear payment records and easy reconciliation. And features such as automatic audit trail tracking, streamlined approvals with notifications and mass payments with a simple CSV upload can help you process thousands of payments no matter how much your company grows.