What is a Purchase Order? Everything You Need to Know

Key Takeaways:

There’s no denying the importance of a smartly planned purchase order (PO). To be frank, skipping a single critical step in the purchase order process can mess up many things – vendor relationships, effective planning, and cost control are just a few examples. It can also leave you with a messy audit trail and makes it difficult to manage cash flow. But what is a P.O. and what do you need to know about them?

The first step in understanding the purchase order process is to examine why it matters in the 21st century and how much of a tremendous impact it can make on business. Purchase orders remain relevant and useful in the modern age thanks to the constant tweaks and innovations made to them. The formula is always being worked on and refined to ensure present-day operations benefit from the clarity and compliance that these powerful documents can help teams achieve.

Purchase order processing is a critical component of procurement that helps businesses maintain control over their purchasing activities. This structured process involves several key stages, from creating a purchase requisition to approving and issuing the purchase order to the vendor. Once the goods or services are received, the business verifies the order against the PO, ensuring accuracy before finalizing payment. A well-managed purchase order processing system streamlines procurement, reduces errors, and enhances accountability, giving organizations clearer visibility into their spending and procurement workflow.

Today, let’s explore everything about the PO order system including the fundamentals of the professional PO process, benefits of purchase orders, best practices in preparing POs and how to use purchase orders effectively.

What is a PO?

To put it simply, a purchase order acts as a documented confirmation of an order placed with a vendor or supplier during the purchasing process. The P.O. is sent by the purchasing department of the company placing the order and then authorized if all the required details are accurate and agreed upon by both parties.

It is a legal document that indicates all the details of the product or service to be purchased and also acts as a sort of contract between both parties binding the purchase of goods or services.  POs also help to streamline your purchase, preventing duplicates or conflicts in the order process. These are just a few of the benefits of purchase orders that makes it a great tool for supply chain management.

WHAT IS A PO IN BUSINESS? 

A purchase order is a legally binding document confirming the buyer's intent to purchase a specific quantity of goods/services for the negotiated amount from the suppliers. PO document establishes terms of payment and showcases the business’s commitment and intent to pay for the specific products. 

WHAT IS THE PURPOSE OF A PURCHASE ORDER? 

A purchase order aims to authorize and document the purchasing process to ensure clarity and transparency. Documented and authorized POs provide legal records, creating audit trails and allowing businesses to manage compliance and inventory effectively. 

WHAT IS A PURCHASE ORDER USED FOR? 

A purchase order is used to authorize the purchase of goods and services from a supplier, as well as document the purchase details such as quantity, price, and dates. 

POs help businesses track spending and manage budgets more effectively, reducing the risks of duplicate POs and invoices. 

Finally, POs allow to establish the terms and conditions for the purchases to avoid risks such as low-quality materials or late deliveries. 

HOW DOES A PURCHASE ORDER WORK? 

The purchase order process is quite simple and can be categorized into a few main steps. 

• Create a purchase request. First, create a PO document and outline everything needed from the supplier. 
• Receive the purchase requisition approval and send RFQs. 
• Send POs to the vendors (if you already agreed to the terms and conditions/have a long-term contract). 
• Get and verify the delivery. 

Receive, verify, and then pay for the invoices with three-way matching.

What is a Purchase Order Process?

The purchase order process is a series of steps that an organization follows to request, approve, and track the procurement of goods or services. This process typically begins with identifying a need and creating a purchase requisition. Once approved, a purchase order is generated and sent to the supplier. The supplier then delivers the requested items or services, followed by the organization receiving and verifying the goods. The final steps involve reconciling the purchase order with the invoice and processing payment. This structured approach ensures clarity, accountability, and control over procurement activities, minimizing errors and streamlining operations.

WHAT ARE THE BENEFITS OF USING PURCHASE ORDERS?

In the world of business operations, keeping things organized is crucial, especially when dealing with buying stuff and working with suppliers. Let's break down the simple yet important benefits that come from having a clear system for buying and working with suppliers.

1. Enhanced Financial Control: Implementing a structured system for documenting procurement transactions contributes significantly to enhanced financial control within an organization. By delineating specific details of each transaction, businesses can establish a clear audit trail, allowing for meticulous tracking of expenditures.
2. Facilitation of Budget Management: Utilizing a standardized documentation process for procurement facilitates effective budget management. Purchase orders, through their detailed breakdown of costs and approved spending limits, provide a practical tool for budget tracking.
3. Strengthening Vendor Relationships: Clear and transparent communication is fundamental in any business relationship. A documented procurement process fosters transparency and trust between businesses and their suppliers, strengthening vendor relationships.
4. Mitigation of Disputes and Discrepancies: Disputes and discrepancies in procurement transactions can be a significant drain on resources and time. A detailed procurement process acts as a preventative measure against such issues by providing a clear record of agreed-upon terms.
5. Compliance with Regulatory Requirements: In many industries, adherence to regulatory requirements is non-negotiable. A well-structured procurement process aids businesses in complying with relevant regulations by documenting each transaction.
6. Efficient Resource Planning: Resource planning is a critical aspect of organizational management, and procurement is inherently tied to this process. A well-structured procurement process provides the necessary insights for effective resource planning.
7. Improved Decision-Making: Accurate and timely information is the bedrock of sound decision-making within any organization. A well-documented procurement process contributes to the availability of reliable data for decision-makers.

While the explicit use of purchase orders may not be highlighted, the benefits derived from a well-structured and documented procurement process are undeniable. From financial control and budget management to vendor relationships and regulatory compliance, the advantages of adopting a systematic approach extend across various facets of organizational operations.

Is a PO a Contract?

Yes. A complete, accurate PO order approved by the purchaser and vendor acts as a binding agreement. As the buyer, you’re responsible for ensuring the PO number, addresses and contact details are accurate, and the same applies to the goods and services you need to order (proper inventory analysis and planning is crucial here). The vendor needs to stick to their commitment once the order is approved, invoices are paid and the receipts are sent. The P.O. process can also serve as comprehensive record for your purchase of goods and services. The legality of this document is one of the key benefits of preparing an invoice and a purchase order.

What’s the Difference Between a PO and a Purchase Requisition?

The purchase order management process is part of a much broader procurement process that includes many other steps and documentation. Purchase orders are one of several documents used in procurement management. A purchase requisition or purchase request form is a completely different type of document also used in the procurement process. It precedes the purchase order’s creation.

A requisition form is used internally at the purchasing company, usually from one department to another to request permission to purchase the goods or services in the first place. The requisition is also sent to the finance team or accounting team to allow the release of funds for procurement. Once the requisitioning is complete and your team has the go-ahead, they can then create the P.O. which will be sent to the supplier.

So while both documents are important for procurement and inventory management, they're totally different from each other. In many cases the purchase order process consists of purchase requisition as one of the key steps in filing a PO.

Want to learn more? Read about the difference between a purchase order and a purchase requisition.

The Difference Between a Purchase Order and an Invoice

In the realm of business transactions, two fundamental documents play distinct roles in facilitating the exchange of goods and services: the order and the invoice. The order, often generated by a buyer, serves as a comprehensive record detailing the specifics of a requested transaction. It typically outlines the quantity, description, and agreed-upon terms for the products or services. This document essentially communicates the buyer's intent and requirements to the seller.

On the other side of the transaction, the invoice is a formal request for payment issued by the seller to the buyer. It functions as a billing statement, providing a detailed account of the products or services rendered, along with their corresponding costs. The invoice also includes essential information such as payment terms, due dates, and any applicable taxes or discounts.

The key distinction between these two documents lies in their timing and purpose within the transactional process. The order precedes the fulfillment of the request and is essentially the first step in initiating a business transaction. It serves as a guide for both parties, ensuring a mutual understanding of the agreed-upon terms before any goods or services are exchanged.

Conversely, the invoice is generated after the products or services have been delivered, signaling the completion of the transaction. It signifies the seller's formal request for payment from the buyer based on the agreed-upon terms outlined in the initial order. The invoice, therefore, acts as a post-transactional document that serves to formalize and conclude the financial aspect of the business exchange.

In essence, while the order sets the stage for a business transaction by detailing the buyer's requirements, the invoice steps in afterward to formalize the financial obligations and initiate the payment process. Both documents play crucial roles in ensuring transparency, accuracy, and a smooth flow of transactions within the business ecosystem. Understanding the nuanced differences between these documents is essential for businesses aiming to maintain clear and efficient financial processes.

What are the Different Types of Purchase Orders Created by Purchasing Departments?

POs are one of several important documents used in the procurement process. Unsure which type of purchase order you need for your specific operations? To better understand the PO process, let’s help you out and look at the four types of purchase orders, briefly summarizing them:

1. Standard POs are as simple as they come but also the most detailed; they’re ideal for one-off or sporadic orders where clarity is a must.
2. Planned POs do just what they say on the tin; they’re optimized for recurring commitments. Planned purchase orders are similar to standard POs, but the biggest change is that delivery details such as the date and location for items are omitted.
3. Blanket POs are similar to a PPO in terms of omitted data, except the item quantity and sometimes even the price and payment terms is also not included. The list of items otherwise remains.
4. Contract POs take the others’ omissions to the next level; the list of items doesn’t appear. Purchase is made using this format of PO when all you need is a binding contract, hence the name.

Noticing a pattern? All four of these purchase orders depends on data accuracy, resulting in informed and more effective purchase orders. Many businesses even leverage P.O. automation to streamline the process and take advantage of powerful new, transparent insights to improve their chances of a healthy, long-lasting vendor relationship. This is a more effective alternative to the manual purchase order process which can be time-consuming and error-prone.

What Does a PO Look Like and What's Included in a Purchase Order Process?

Using this example below, we can paint a clearer picture of what the purchase order system looks like. Notice the specific contact and address details included. This indicates that the document is a standard P.O., as explained earlier, as these details are retained and not omitted.

Check out some great purchase order templates.

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How to Create a Purchase Order - Digging into the PO Process and Best Practices

Let’s explore every critical step of the PO creation workflow including planning, submitting, and (hopefully) achieving PO approval. Note that the process of making business purchases allows some flexibility so the purchase order process steps may vary from one case to the other. However, the key steps highlighted below are the general steps to create purchase orders in a standard PO system

• Data and content analysis to inform the order. This process will dictate what to include in the order requisition to be sent for approval.
• Purchase requisition complete, internal requisition team authorizes a purchase
• Initial order drafting.
• Send-off order form for approval. As part of the approval process, the procurement team may also review the purchase order if necessary before it is approved.  
• Upon purchase order approval, the procurement department issues a purchase order and the PO is sent to the appropriate vendor.  The purchase order remains open until all the remaining steps involved in fulfilling the order are completed.
• Confirmation of order details by the vendor. Upon confirmation that the products and services that you ordered can be fulfilled, the PO acts as a binding contract
• Three-way matching to confirm purchase order number and contents, after which you approve purchase orders
• Payment and completion of order obligations by the vendor/your company

The order is closed when final step in the purchase order process highlighted above is completed. The collective goal and benefits of using the purchase order management steps above is simple: minimize hassle, make sure everyone is on the same page, and create a document that acts as a binding contract to ensure all parties are aware of the terms and condition and deliver on their promises. This document plays an important role in controlling business purchases and managing procurement effectively.

Automate Purchase Order Process

Purchase order management software is a digital platform designed to automate and streamline the entire purchase order process within a business. This system replaces traditional manual methods with a centralized, electronic solution, facilitating efficiency and accuracy. To use a purchase order system, businesses typically input key details such as product descriptions, quantities, and vendor information into the system. Once initiated, the system automates the creation, approval, and tracking of purchase orders, eliminating the need for paper-based documentation and reducing the risk of errors. It can integrate with inventory management and financial systems, providing real-time insights into stock levels, expenditures, and order statuses. Automating the purchase order process not only saves time but also enhances transparency, accountability, and compliance with organizational protocols, leading to a more streamlined and effective procurement workflow.

You can automate the purchase order process and achieve greater efficiency in managing the process of creating POs by using an e-procurement software like Tradogram. This platform has tools for creating various procurement documentation including requisition forms, purchase orders and invoices automatically. Automating the PO process allows you to complete this crucial procurement step quickly and effectively while eliminating errors and keeping all your orders in one place.

Additional Resources:

• Types of Purchase Orders & Purchase Order Examples
• Purchasing Advantages: What Does a Purchase Order Look Like?
• What is Purchase Order Automation?
• What Is Purchase Order Management?
• Purchase Requisition vs Purchase Order