What is a purchase order? Protect cash flow with purchase order management

A purchase order is more than a simple document listing the products you wish to buy; it's an essential component of the broader procurement process. This process helps businesses track and reconcile purchases of goods and services, like raw materials, equipment, and IT support.

Tracking and managing purchases can also help you protect your cash flow. This is good news, considering that 45% of small businesses surveyed in the Quarterly Small Business Insights report cash flow problems. 

This article explains the purpose of a purchase order, reviews the six-step procurement process, and shows how combining POs with automation can help businesses better manage cash flow.

Jump to:

• How do purchase orders work?
• The key components of a PO vs. an invoice
• The four types of purchase orders
• The 6-step procure-to-pay (P2P) process
• Why automation is essential for small business cash flow
• Choose the best payment setup for your business

How do purchase orders work?

A purchase order is a document that outlines the specific products or services a buyer (your business) plans to purchase from a supplier.

Once the seller (supplier) accepts the PO terms, the purchase order becomes a legal contract, guaranteeing that you, the buyer, will receive the items or services at the agreed-upon price. 

In addition to being a legally protected document, POs are an essential part of the procure-to-order process (P2O). The P2O process organizes and manages each stage of the purchasing process, from requisition through final payment. 

How do purchase orders protect cash flow?

Businesses, large and small, use purchase orders to order goods and services. For example, a bakery might need to order flour and other ingredients in bulk from a supplier. To do this, they would create a purchase order listing how much flour and other ingredients they need, along with the price. 

The supplier reviews the purchase order, pulls their inventory, and sends the goods to the bakery via the preferred shipping method. Once delivered, the supplier issues an invoice asking for payment.

This process helps a business quickly identify when money is owed, how much, and to whom. It can also help a business plan out invoice payments to ensure a stable cash flow.

Can a seller cancel a purchase order? 

Yes, a seller can cancel a purchase order. Sellers cancel purchase orders for a few reasons. For example, they might not have the items in stock that a buyer needs or may reject the price or terms a buyer is asking for. 

When this happens, the seller may request the buyer make revisions to their purchase order or, if changes can’t be made, the buyer needs to find a new seller.

What is a purchase order number?

Each purchase order comes with a unique purchase order number. For example PO9567 or PROJ462-01. These unique PO numbers make it easy for both the buyer and the seller to keep track of delivery and payment. 

For buyers, the PO number helps track their order throughout every stage of the procurement process. This way, the buyer can ensure they receive the right items or services requested.

The key components of a PO vs. an invoice 

POs and invoices are both part of the procurement management process, and they contain similar information, but they arrive at different times. 

A purchase order, created by the buyer, is used to procure goods and services. The document confirms what is being ordered and serves as a commitment to pay the agreed-upon price. A PO includes details like the PO number, ordered quantities, price details, shipping address, and expected delivery date. 

The seller creates an invoice to request payment for goods and services after they are delivered. The document lists important information like what was ordered, when the material was delivered, what discounts applied, and the payment terms. 

The four types of purchase orders

There are four main types of purchase orders used to formalize different kinds of transactions. A Standard PO is the simplest, used for a single, one-time purchase with a fixed price, such as a coffee shop buying an espresso machine, and there are several others suited to different purchasing scenarios.

Here are the most common types of POs:

• Standard PO: Used for one-time purchases at fixed prices (like buying a new machine).
• Blanket PO (BPO): Used for regular, recurring purchases from the same vendor at pre-negotiated prices (like weekly cleaning supplies).
• Contract PO (CPO): Similar to a BPO, but offers flexibility in changing items and quantities (like adjusting the number of software licenses).
• Planned PO (PPO): Used when the delivery date is unknown and dependent on future events (like ordering building fixtures based on construction progress).

These different types of purchase orders can also offer unique cash flow benefits. For instance, a standard PO lets you take advantage of current sales, a BPO gets you a discount on items your frequently purchase, and a PPO can help you plan out the expenses for a large project.

The 6-step procure-to-pay (P2P) process

A purchase order is just one step of the procure-to-pay (P2P) process. There are six steps starting with requisition and ending with payment. Let’s explore each of these steps in more detail.

Step 1: Purchase requisition

The purchasing process starts with a need for supplies or services. This need is often conveyed using a purchase requisition form. For instance, a contractor at Connor’s Construction Company needs lumber to add a 500 sq ft detached garage to a customer's home build. To request the material be ordered, they submit a requisition form for the supplies to the procurement manager. 

A requisition form should include a list of required materials, the estimated cost, the date the supplies are needed, and a reason for the order. There is also a place on the form for the appropriate person or department to sign and approve the request. 

It's worth noting that for solopreneurs and smaller companies, the requisition step is often skipped, with PO creation being the first step. 

Step 2: PO creation

After a requisition is approved, the form is used to create a purchase order. The PO will typically include more specific information, such as item descriptions, pricing, and delivery dates. Once complete, this document is sent to the vendor. 

For example, the procurement manager at Connor’s Construction Company creates a PO for the lumber needed using the contractor's requisition form. The manager then sends the PO to Joe’s Lumber Yard, a company they’ve purchased from before. 

Alternatively, a company can use a quote or a request for quote if this is the first purchase with a particular supplier, or they want to compare for better prices and availability. Once the vendor and pricing are known, a PO can be created. 

Step 3: Acceptance

Once the vendor has received the PO, they can accept or reject it. Alternatively, they can send it back for revision if they don’t have the inventory or spot a pricing issue. For example, Joe’s Lumber Yard sees that the plywood price is listed at $33.75 when it is actually $34.95. So they send the PO back to Connor’s Construction Company for revision. 

Once the vendor approves a PO, it becomes a legally binding contract.

Step 4: Order fulfillment

Now that the vendor has accepted the contract, they can begin fulfilling the order. In our construction example, this means that Joe’s Lumber Yard will deliver the materials to the job site by March 20th. 

Upon delivery, the seller will usually provide a delivery receipt, goods receipt, or packing slip. 

Step 5: The three-way match

After the materials ordered have been delivered, the vendor will send an invoice. This begins the three-way matching process involving three documents:

• The Purchase Order: What was ordered?
• The Receiving Report (packing slip or receipt): What was delivered?
• The Vendor Invoice: What the vendor says you owe.

Matching all three of these documents is key to maintaining clean accounting records. Once the documents have been matched, payment can be authorized and issued. 

In our example, Joe’s Lumber Yard sends Connor’s Construction Company an invoice. The construction company matches it to the delivery receipt and the PO. Now that the records match, Connor, the owner, approves payment to Joe’s Lumber Yard.

Step 6: Payment 

The final step in the P2P process is to issue the actual payment. After verifying the three-way match is complete, the accounts payable team (or the person performing these functions for your business) can then process the payment. Payment can be issued via check, Automated Clearing House (ACH), or credit card. The AP team will also record the payment in the company’s general ledger. 

Since the business owner already approved payment in our construction example, the AP team now schedules a check to be sent to Joe’s Lumber Yard in compliance with their net 60 terms. The team also records the payment in the ledger to ensure the company’s accounting is accurate. 

Why automation is essential for small business cash flow

As a small business owner, managing your POs and the purchasing process as a whole can be time-consuming, complex, and costly. But with automation, you can cut costs and protect yourself from compliance and budgeting issues.

Stopping over-budget purchases

More than half of small businesses wait 30 or more days to get paid, making budget problems common. If you issue payment to a vendor, but you are cash-strapped because of unpaid invoices, you could quickly find yourself in the negative, risking nonsufficient funds (NSF) fees or needing to rely heavily on costly credit or outside funding. 

With a cash flow resource like QuickBooks, you can ensure all purchases align with your budget. The automation features use spending limits and an approval process to prevent cash flow gaps. Plus, you have the support of the Payments Agent, which uses AI to provide cash flow insights so you’ll always know exactly where your money is.

Preventing duplicate payments 

If you are matching orders to payments manually, it's only a matter of time before a simple error costs you a chunk of change. Imagine, for instance, that a payment doesn’t get correctly tied to an invoice. Seeing an unpaid invoice, you issue another payment, not realizing that you’ve made a duplicate payment until the vendor contacts you. 

With automated PO management, such as the tools offered with QuickBooks, you prevent duplicate payments, protect yourself from fraud, and reduce data-entry errors. In fact, a recent Gartner survey showed that businesses adopting technology for data entry reduced financial mistakes by 75%. 

Streamlining auditing and compliance

The successful management of your POs and purchasing process not only helps your business save time and money but can also help you prepare for tax filing and ensure compliance with regulatory, industry, or supplier requirements. 

With an electronic PO system, you’ll create a clear audit trail for every purchase, and you’ll have all the documentation necessary to investigate any financial discrepancies that arise. A system like QuickBooks simplifies your tax preparation and provides protection against IRS penalties. 

Choose the best payment setup for your business

Not only do POs help you simplify your inventory and accounting processes, but they are also legally binding agreements recognizing that you are getting goods or services in exchange for payment. With QuickBooks Payments features, you can schedule payments ahead of time and use automated reconciliation to guarantee your payments, invoices, and POs always match up.