What is a Purchase Order? Everything You Need to Know

As an entrepreneur, you wear many hats. And while adding even more paperwork is not what any business owner needs, there are benefits to implementing a purchase order (PO) process as part of your business. But if you’re not sure where to start, you’ve come to the right place. No matter the size of your business, a purchase order system will keep things organized, traceable, and may even help save you money in the long run.

In this article, we’ll break down everything you need to know about purchase orders, what information you need to include in your purchase order request, and the importance of purchase order automation.

What is a purchase order?

A purchase order is a document that a buyer submits to their supplier (also called the vendor or seller) to indicate what products or services they wish to purchase, in which quantity, and at what price. A PO will also indicate the purchase order terms, such as when the order will be delivered and what the payment terms are.

A purchase order serves many functions at once. First, it provides an internal record of purchase that details what was ordered and at what price. Second, it lets a vendor know their customer would like to place an order with them and gives them the opportunity to accept the order. Finally, it acts as a legally binding document between the buyer and the seller. This gives every party involved some peace of mind. The buyer can be confident that their supplier will deliver their order within the agreed upon time frame, and the supplier can be certain that the buyer will pay for the order according to the agreed upon contract terms.

Why are purchase orders important for my business?

Depending on the size of your business, you might be able to get by without creating a system for issuing purchase orders, but it’s never too early to use a proper purchase order process. Adopting the purchase order format is a great way to keep your spending on goods and services organized, and it will be even more important as your business grows and it becomes more difficult to keep track of inventory management. Plus, many vendors actually require the use of a purchase request form. Either way, if you want to project professionalism, it’s wise to have a purchase order template you can use anytime.

What is the purchase order process?

Implementing the use of purchase orders in your business involves more than just creating a purchase order template for you or your employees to use. It’s also important to understand the purchasing process, so that you can avoid confusion and get the most out of your purchase order document. To prevent any hiccups along the way, follow these simple steps each time you create a new purchase order:

Create a PO

As the purchaser, the first step is to decide what product or service your business intends to buy. You should be familiar with the prices for products, the amount required, and the order processing time. If you don’t already have this information, you can contact the vendor before you put together a PO. Fill out your purchase order template detailing all the specifics of your order, including delivery location and payment schedules.

Approve PO

Depending on the size of your business and the type of purchase transactions being made, there may be a person or department in your company that is in charge of purchase order approvals. If you’re a sole proprietor, or if you handle all purchases yourself, this step won’t apply to you. However, if your organization is large enough that you have multiple departments, consider having a dedicated purchasing department head approve all purchase orders and track your inventory to help maintain your business budget.

Send PO to the vendor

Once your purchase order is complete, it’s time to send it to your supplier. If they do not approve the PO, contact them to find out why. Perhaps your pricing on the PO was incorrect, they are low on stock items, or you have not fulfilled their minimum order quantity.

PO is received 

Most of the time, the supplier will approve the PO. It becomes a legally binding document. Once a purchase order is approved, the seller will prepare the order.

Receipt of goods or services

The seller will deliver the order within the time allotted in the purchase order terms.

Invoice for payment

When the vendor delivers the product or service outlined in the purchase order, they will issue you an invoice with an order number corresponding to your original PO. This can be compared to your copy of the PO and the packing slips to make sure all the numbers, such as quantities and prices, matchup between the two documents.

PO closure

Once the order is delivered and the invoice paid, the PO can be marked complete and filed away using your document management system, and the invoice can be marked as paid.

Following these steps every time will result in far fewer unexpected expenses and incorrect orders for your business.

What is the difference between a purchase order and an invoice?

People sometimes use the terms purchase order and invoice interchangeably, but they’re actually two completely different documents. While a purchase order is issued by the purchaser to the vendor, an invoice goes in the other direction, from the vendor to the purchaser.

An invoice is sent only once a PO is approved. The main purpose of a purchase order is to indicate the details of an order being placed, while the main function of an invoice is to show the amount owed. While it’s important to know the basics of invoicing as an entrepreneur, in your interactions with vendors, you’ll be issuing purchase orders and receiving invoices.

What should I include in my purchase order template?

Luckily, there are lots of great purchase order templates online that you can plug your own information into, so you don’t need to create one from scratch unless you want it to match your business branding. You can also take a look at a few purchase order examples online so that you can get a sense of how they’re usually formatted before customizing your own PO template.

When it comes time to create your own purchase order form for your business, include all of the following:

PO number

This is an important part of your purchase order because it will help you keep all your orders organized, making them easy to refer back to. Your vendor will also use it when they issue you an invoice and packing slip. You can refer to the PO number to match up the purchase order, invoice, and packing slip to make sure that everything matches and they have made no errors. This is called three-way matching. You can come up with an alphanumeric system that makes it easy to create PO numbers. For example, you can have a four-letter code for each vendor, followed by 001 for your first order for them, 002 for the second, and so on.

Date of purchase order

This shows when the order was sent. It can also be a factor in determining the date you have to pay by, since your payment terms with your vendor may begin the day you place an order.

Payment terms

Payment terms are typically agreed upon in advance. If you haven’t yet established relationships with vendors and this is your first PO, you may have to pay upfront. For subsequent orders, you may only have to pay for a portion up front and the balance on delivery, or you may even have a longer period to pay. Establishing a history of meeting your payment terms on your POs, particularly with large vendors, can help you get access to business credit in the future.

Delivery details

This includes the delivery date, based on the agreed upon lead time for the product or service you are ordering. Also, include the shipping method and terms. 

Address

Include your business name and shipping address. If your shipping address differs from your business mailing address, it’s important to include it on your PO. 

Product details

Make sure you include the item name or SKU (Stock Keeping Unit) number, description, quantity, and price for each item on your purchase order form.

Total cost including tax

Once you’ve created a template that includes these sections, you’ll be able to plug in the information for each purchase order without worrying you’ve forgotten anything. 

Why you should automate your purchase order process

Many businesses go the informal route when they’re just starting out by calling or emailing their vendors when they want to place an order. However, there are good reasons why it’s worth taking a bit of time to create a PO template that you can use every time. They include: 

Budget management

Using POs helps you manage your budget. Assuming you have a document management system in place (and you should!), you can easily look at your past POs and have all previous spending visible in one place to get a quick and thorough overview of your finances. Are you spending more in one area than you think you should? Or maybe instead of placing multiple small orders for one product or service, you could merge them into a large order and bring down your costs. Using POs is an easy way to gather and analyze what your business is spending.

Legal protection

POs may offer you legal protection. Since it’s considered a legal document once approved, a PO can help you if your supplier isn’t holding up their end of the bargain. Even if you just have a misunderstanding about something, it’s much easier to go over your PO with your vendor than to dig through old emails or try to recall verbal conversations.

Simplify the process

A streamlined ordering process makes things easier for your vendor. They won’t have to follow up with you for missing information before approving your order, because all the relevant details are already there in the PO. It also makes for easier accounting, especially if you have a bookkeeper or accountant who isn’t aware of every transaction made by your business. If you end up being audited, it will be much easier for your auditor to look at your POs and match them up against invoices than for you to have to dig through old emails and receipts to try to make sense of business transactions that took place years ago.

Is there any reason I shouldn’t use purchase orders?

There are some business expenses that won’t necessarily be subject to purchase orders. For example, POs aren’t used for regularly recurring expenses such as utilities. However, many of your business expenses will benefit from the use of a PO purchasing process.

As an entrepreneur, there are already so many tasks you have to juggle all at once. Implementing a system for using purchase orders in your business is a small thing you can do that will really streamline your operations and make accounting much easier.