What Is a Purchase Order?
If you own a business or work in higher positions, you may have heard of a purchase order before.
In this article, we are going to take an in-depth look at what a purchase order is, why you may need one, and some common procedures. Towards the end of this article, I will also be giving you a free purchase order template in case you need one.
What is a Purchase Order?
It is a commercial document that is sent from the buyer to the supplier.
It is the first official offer between both parties and often includes details such as:
- Types of products
- Quantity of products
- Agreed prices for products or services
- Delivery date
- Payment terms
- Payment information
Although sometimes it is confused with an invoice, they are quite different. A purchase order is sent to the supplier from the buyer, which is the opposite of how an invoice works. And, it also contains a legally binding contract, whereas an invoice is used as proof of transaction (or to get paid).
The reason we use purchase orders is to control, and also keep an overview of purchases from external vendors. Plus, they are also a legally binding contract between the two parties to make sure everything goes down as agreed.
Of course, purchase orders are not used for every purchase you make.
Usually speaking, purchase orders are used for B2B (Business to business) deals, for example, for inventory purchases or other high-value orders.
In this case, the business owner that needs the inventory sends the supplier a purchase order with the details named above. At this point, there is no transaction yet. It is only a way of letting the supplier know what is needed.
Because there are no payments made, nor any products received yet, there is also no record entries for either party yet. Later on, when the goods are received and the payment is made is when there are record entries for both parties.
Why Are Purchase Orders Important?
So, why are purchase orders important? And why are they used?
The main reason why a purchase order is used is to create an order as an official document. If you, for example, would like to purchase 100 chairs, you could send a purchase order for this to the supplier or vendor. Now, if the supplier for some reason only sends the wrong quantity, the wrong product, or type, then you have an official document to state that this wasn’t your order.
Purchase orders are used to create initial clarity. If you don’t use purchase orders, you will find that there can often be added confusion. For example, if you were to tell the supplier the details of your order over the phone, you wouldn’t have any proof of what your order was.
Now, if something goes wrong, you’re in a bit of an awkward situation as it’s your word vs the suppliers. A purchase order is a legally binding contract to avoid this.
Common Purchase Order Procedure
To help you get a better understanding of what’s involved in a purchase order, I have outlined some common steps down below. Keep in mind; these steps may vary slightly, depending on the companies involved.
Usually, the steps to creating a purchase order are:
- Create the purchase order
- Get the purchase order approved
- Select Supplier and negotiate a contract
- Send purchase order
- Receive the goods/services
- Matching paperwork
- Records are entered
- Authorize the invoice; then, the Supplier is paid
- Purchase order closure
For more information on the whole process, check out the steps below. The steps below are slightly different, just for convenience, but the overall process is the same.
1. Purchase Order Creation
The first step in the procedure is the creation of the purchase order. They can be created from approved requisitions, or in some cases, like recurring purchases, they are prepared from scratch. Usually, purchase orders are created by the procurement team or administrative staff.
For small businesses, it may be the business owner creating the purchase order as well.
2. Purchase Order Approval Flow
Now that the purchase order has been created, it has to be approved by the finance team and some other related positions within the company, depending on the size. Again, if this is a small business, it may only be the business owner who needs to approve it.
3. Dispatch
Once everyone who needs to approve the purchase order has done so, it is then sent to the Supplier.
Usually, this is done through one of the following forms of communication:
- Letter
- Fax
4. Binding Contract
After the order has been accepted by the Supplier, it becomes a legally binding contract. This purchase order can then be used to solve any legal disputes between the two parties.
5. Goods Delivery
The next step would be that the supplier delivers the goods. At this point, the buyer can check the quality and notify the supplier, in case there are any problems.
If there are any problems with the order, both parties will first investigate them. Then, they will try to come to a mutual agreement before legally disputing it.
6. Matching Paperwork
After the goods are delivered, the buyer then performs a three-way match with the purchase order, receiving report, and invoice.
This is a process to prevent fraud or losses through mistakes. All documents are checked to see whether they all match each other.
7. Purchase Order Closure
If the three-way match goes well and there aren’t any errors found, the purchase order is then closed. At this point, the approved invoice will be ready to pay by the buyer or the buyer’s finance team.
And of course, the records are now entered as there have been transactions and goods received.
Free Purchase Order Template
To make your life much easier when sending purchase orders, I have created a template for you to use. It’s nicely laid out and has all the information you need listed so that you can easily fill out the details of your purchase orders.
If you would like to download this template, you can check out my free purchase order template page. You will also find instructions on how to use it so that you don’t make any mistakes.
Further reading is available on the Purchase Control website and more bookkeeping tasks are available on the bookkeeping basics page.
