When you need a new set of labels for your product, what are the key documents needed? You will probably think of a ‘purchase order’. The term ‘purchase order’ is often heard when a transaction of good or service is being raised by the company.
However, if you haven’t been involved in a business purchasing process before, you might be wondering why companies use purchase orders. Purchase orders are like the glue that holds your company together. They enable you to keep track of your orders and collect payments promptly. Any business that requires raw materials or external services needs to issue a purchase order, possibly to several vendors.
To provide better clarity of it, we have listed 7 key points about the purchase order you need to know.
Table of contents
- 1. What is a purchase order?
- 2. Purchase Order Versus Invoices & Purchase Requisition
- 3. Types of Purchase Order
- 4. Information Required on a PO
- 5. Purchase Order Process Steps
- 6. Why Purchase Orders Are Important for Your Business
- 7. Why automate the purchase order process?
- Getting Started with Purchase Orders
1. What is a purchase order?
A purchase order, or PO, is an official document created by a buyer and delivered to the seller for the sale of products or services they wish to purchase. It is the written confirmation of an order being placed and a legally binding contract between the two parties when the document is approved by the seller.
2. Purchase Order Versus Invoices & Purchase Requisition
Every employee needs to know that purchase orders should not be confused with invoices. Although both of them contain similar elements, they are two different documents that serve different purposes. The buyer produces purchase orders while invoices are created by the seller or vendor – the individual or company supplying materials, items or work. When a purchase order is accepted, the seller will issue an invoice to the buyer based on the purchase order. An invoice is a commercial instrument to charge the buyer for their provided goods and/or services.
On the other hand, purchase requisitions are different from purchase orders too. Compared to PO, a purchase requisition is more like an internal document in which one department asks another department (usually the finance department) for permission to buy products or services. No particular orders are being made at this stage, but merely getting approval to do so. Typically, a company will issue a purchase request form when the proposed purchase over an amount set by the company.
3. Types of Purchase Order
Now that you know purchase orders are used by companies to improve business spend management, do you know there are several different types of them?
Every company has different requirements when procuring from their suppliers or vendors. Hence, there are different types of purchase orders available to them in today’s business world. Below are 4 ways to determine the different POs and how they are different from each other.
- Standard Purchase Orders (PO)
Among the four, the standard POs is the most common type of procurement where you are already certain of your purchasing requirements like the price, quantity and timeframes for payment and deliveries. Standard PO often falls under the situation where you want to make a one-off order. For instance, a standard PO when purchasing a new printer for the office.
- Planned Purchase Order (PPO)
For a planned purchase order, you know what products or services you need but are unsure of how much and when. Pricing may not be known either. They are used for orders approximately predicted in expectation of future needs. Delivery schedules are processed on a per-order basis and comply with the general schedule set out in the PO. For example, you may decide to order reams of copy paper but is unsure when or how often it will be needed. In this case, you can initiate the purchasing process by issuing a blanket purchase order.
- Blanket Purchase Order (BPO)
The Blanket PO is commonly used by procurement professionals to purchase a product or service over an extended timeframe. Blanket POs requires the buyer to agree to buy specific items or services from a single supplier, but not at any specific quantity. It involves planning several orders at a time, rather than one purchase order. With a single contract, you can negotiate discounts based on bulk orders, which means the buyer can take advantage of low prices based on the amount ordered. For example, your company requires 100,000 pieces of paper per year but doesn’t know how much you need per delivery or when the dates of delivery should be. In this case, you will be issuing a blanket purchase order.
- Contract Purchase Order (CPO)
Contract Purchase Order, as its name suggests, is a binding legal agreement for a particular purchase, contract POs create a high-level, long term agreement. The quantity and goods that your company want aren’t specified in this PO, but only the terms of payment. This kind of purchase order is more like a binding agreement that your company will buy from a particular seller in the future. Therefore, you may refer to the contract PO to order a product when issuing a standard PO.
4. Information Required on a PO
Whether your company is raising a purchase in an old-fashioned way by issuing out a paper document and sent to the vendor through fax or mail or creating POs electronically, there is some information that a proper purchase order format should include.
The information needed is:
- The name of your company,
- Date of issuance
- Quantity, description, and price of the goods or services per unit,
- Delivery date, billing details, delivery address and invoice address of your company,
- Payment terms, purchase order number and signature of relevant stakeholders.
Today, you can easily find proper purchase order templates in excel or even word form on the internet. Thus, POs play an important role in the accounting system and facilitate recordkeeping. Although the final form of PO might vary by business, there is always an important takeaway which is – the more detail a PO, the more value each PO generates that leads to lower unnecessary risk a business must bear. You should always clearly communicate requests to vendors to avoid any confusion when they receive the PO.
5. Purchase Order Process Steps
In the purchase order process, there is a different range of stages involved. The PO process is a part of a wider procurement process involving the confirmation and specification of the actual necessity for products or services before the purchase. It also entails payment processing and the results of auditing. These can vary from business to business, but the most widely used are the ones mentioned in the following.
- After the approval of purchase requisitions is made and sent to the seller or vendor, the purchase orders are created. You then decide whether to accept the contract. Once the contract negotiation process is done, the purchase order has become a legally binding contract between you and the vendor.
- You will then record the purchasing order officially and the vendor will begin to do what is required of them to fulfil the order.
- A three-way matching process is carried out by your company when the goods or services are shipped by the vendor. During the process, you verify the purchase order, the order receipt/packaging slip, and the invoice to validate the accuracy of the order. If there are any discrepancies found, you can request a return until all items or services pass the quality check and requirements.
- Lastly, the vendor invoices for the order and you will pay the invoice according to the terms and conditions laid out in the PO. Purchase orders are finally closed and your accounting team approves the invoice and enters it into the accounts payable records.
6. Why Purchase Orders Are Important for Your Business
When most small businesses start, they forgo a purchase order process in favour of a more informal approach. During this stage, it might still not be a big issue because they tend to have a smaller amount of procurement that’s simple and straightforward. However, as companies grow and their purchases become more complex, specific and urgent, a good PO system is extremely important for them to avoid any confusion.
For example, if your company receives orders without a PO number for review, it can be a struggle to find out where the request went wrong. Thus, POs are a basic requirement for doing business of all sizes.
Here are 4 key benefits of purchase orders to business:
- Tracking Inventory and Costs
A well-organized purchase order system makes inventory and shipping management simpler as they allow us to track our orders easier and also monitor inventory levels. It is a way to track precisely what your money is spent on and when. In other words, you can prevent over-purchasing with POs that results in money-saving. Today, many government departments and authorities have insisted on issuing PO forms before agreeing to pay an invoice so that they can handle unexpected expenses.
- Avoid Audit Problems
POs help you avoid audit problems as they work as evidence. Orders can be placed and documented on scraps of paper in some smaller firms, but not for big companies. By providing auditors with a conclusive audit trail and a simple way to cross-check invoices and packing slips, it helps demonstrate a healthy flow of orders and income or sensibly-managed expenditure that eliminates tons of stress from the auditing process. The reliability of purchasing records will then naturally increase.
- Help to Forecast and Anticipate Market Trends
Although economic navigation is a constant response to changes, purchase orders can help your company maintain the correct course regardless of external circumstances. With the information of PO history, it provides key insight into company performance, which gives you the tools you need to identify trends and market cycles. In other words, careful purchasing records allow you to predict the future and prepare for it.
- Provide Legal Protection
The purchase order serves as a legally binding document that gives your company legal protection. They protect both parties, as what’s been ordered and the agreed pricing is laid out in black and white. This makes it difficult for vendors to increase charges unexpectedly. It can also be hard to definitively prove what went wrong with a purchase without a paper trail. Imagine your company has ordered twenty tables from a supplier and has paid for the amount, but then on the delivery day, only nineteen tables arrived at the office. Who is to blame? Most importantly, POs help to add an extra level of fraud prevention as they provide evidence of purchasing decisions with all the details required.
7. Why automate the purchase order process?
Purchase orders have always been printed in the past and completed manually and routed for internal approval. This kind of old-school method could take weeks to complete, which is very time consuming, inefficient and costly to maintain. There are too many documents needed just to process a single PO. A recent study conducted by American Productivity & Quality found that using a paper-based system for PO processing can cost companies as much as $506.52 per PO. Hence, your organisation should automate the purchase order process through digital. Here are some of the best reasons for you to automate your manual purchase order process:
- Save Time and Money
By implementing an electronic PO system like ADAM, enhances the efficiency in PO management, with no lost or delayed POs. The hassle of using manual pen-and-paper orders can be avoided since all the important documents are monitored in a centralised system with an audit trail telling related departments what actions should be taken on the document. You don’t have to waste time looking for form information. Less wasted time results in saving money too. It becomes easier for the finance department to convert orders into invoices for payment with detailed information available in a single system.
- Improve Security
Filing cabinets filled with records and emails are not a safe place to store confidential information about your company. Misplaced documents can easily be placed in the wrong hands. If the related department can’t keep it safe, they are at risk of losing it. With an automated purchase order system, you can store everything in a single system that is safe and only accessible to authorised individuals.
- Improves Delivery Times
Today, your company should be able to adapt more rapidly to changes in the economic and business climate as technology accelerates. A successful e-procurement software not only manages to benefit you but also the vendor because it is easier for both of you to process and track the order and lead to faster delivery. The automation system allows them to confirm the customers’ orders, assemble their goods and issue an invoice in a simpler and faster way. As a result, it saves both parties time and keeps operations going more effectively.
- Fewer Errors
It can’t be denied that humans continue to stay ahead of computers in many ways in this period. However, there are several things that computers do better than humans, especially repetitive tasks that require accuracy. For instance, when it comes to entering POs containing identical or almost identical details, humans are likely to make errors. It can be all too common to unintentionally alter information and end up with inconsistency in the entry of data or handwritten orders. Most importantly, when errors are made and amendments or corrections are required, a manual transaction needs to fully redone rather than just a simple update. Thankfully, an e-procurement system like ADAM able to produce error-free POs within a timeframe- allowing people to do what they do best.
Getting Started with Purchase Orders
We hope this article was insightful to you and that you have a better understanding of what a purchase order is and why it is so important. PO, when implemented properly, will help you keep track of your supply needs and make smart financial decisions for your company.
A purchase order details the items the buyer agrees to purchase at a certain price point. It also outlines the delivery date and terms of payment for the buyer.
A buyer creates a purchase order to be fulfilled by a vendor. The vendor then issues an invoice for the purchased items or services. The buyer pays for the item.
Buyers use purchase orders to begin the purchasing process with a vendor. After receiving a purchase order from the buyer, vendors issue sales orders to the buyer, verifying details and approving the purchase.
It is possible to cancel a purchase order after it has been issued, as long as the vendor has still not been paid. The buyer who was in charge of issuing the purchase order would receive the request.