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A guide to purchase orders: What they are and how they work

Whether you’re a small mom-and-pop shop or a large corporation, keeping track of inventory and managing purchases can be confusing. One way to prevent any discrepancies is by using a purchase order. Purchase orders outline an order a customer is making from a vendor.

To help you better understand purchase orders, we’ve created this complete guide on what they are and how they work. Read through to learn all about purchase orders, or use the links below to jump to a specific section.

What is a purchase order?

A purchase order (PO) is a document between a business and a supplier that outlines the products or services a buyer wants to purchase.

Purchase orders include the following information about a transaction:

  • The names of the buyer and seller
  • Type of services or items a business wants to buy
  • Quantity
  • Terms of payment
  • Agreed-upon price
  • Delivery date

Each purchase order comes with a purchase order number (PO number) that makes it easy to track in the purchase order system. The point of a purchase order is to streamline the buying process to ensure payment and inventory tracking processes run smoothly. Sometimes, buyers and sellers will use a blanket purchase order. Blanket purchase orders are used for orders that require multiple payments over time.

Are purchase orders legal documents?

Purchase orders are not legally binding at the time they’re sent. Once a seller accepts the terms of a purchase order by signing the PO, or otherwise accepting the order in writing, the document becomes a contract. A PO can also become a contract if the seller delivers the services or goods outlined in the purchase order.

Purchase orders vs. invoices

If you’re a new small business owner, you may be confused about the difference between purchase orders and invoices. While they both sound like they perform the same function, they’re quite different from each other.

A purchase order is initiated by the buyer. On the purchase order, the buyer makes a list of the goods requested from the seller, whether it’s a product or a service. The buyer also lists the items, model numbers or SKUs, along with the quantity, delivery date, and price per unit. The more detail is included in a purchase order, the better.

Once a vendor receives a purchase order, they will deliver the purchased items before payment.

On the other hand, invoices are initiated by the seller to collect payment. An invoice is a document a seller uses to request payment from the buyer. When a vendor delivers a product or service, they send an invoice that outlines how much the buyer owes and the payment terms. Similar to how a purchase order has a PO number, invoices have an invoice number. This number is used for tracking purposes for both the buyer and seller.

For example, let’s say Connor owns a construction business and needs 100 sheets of plywood. He will create a purchase order listing how much plywood he needs and send it to his local lumber yard. His local lumber yard will then deliver the plywood and send an invoice detailing how much he owes and asking for payment.

While purchase orders and invoices differ, they do have some similarities. Both purchase orders and invoices include:

  • Order details
  • Mailing address
  • Price
  • Contact information

In addition, the PO number is usually listed on the invoice as a way to compare what the buyer ordered and what they’re receiving.

Bottom line: The purchase order is the confirmation of an order, while an invoice is a request for payment.

Why do you need a purchase order?

There are a few reasons why you might need a purchase order. Overall, purchase orders help automate the purchasing process, ensuring nothing falls between the cracks. Some of the main reasons why companies use purchase orders include:

  • Budgeting: Creating a purchase order allows companies to manage their budget better. This is because they’ll be able to see what items they need to buy and factor it into their budget to spend smarter.
  • Faster deliveries: Purchase orders schedule when deliveries need to be made, so by sending them to a vendor in advance, they can ensure your purchase arrives on time.
  • Auditing: Should financial discrepancies arise, purchase orders create a clear audit trail that documents your purchases for reference if something goes wrong.
  • Legally binding: Accepted and signed purchase orders are legally binding, giving both the buyer and seller peace of mind. This is because the buyer is protected once the document is approved, meaning they are guaranteed to receive the items at the designated price point. On the other hand, sellers are protected in the event the buyer refuses to pay.
  • Transparency: Purchase orders are used by multiple teams in a company, such as the procurement, operations, and finance departments. Purchase orders allow these teams to work together to manage orders and keep tabs on what deliveries are coming in and which ones are pending.
  • Setting expectations: In a purchase order, companies should clearly articulate what items or services they need, the price point, and the delivery date. This sets clear expectations of what needs to be delivered and serves as documentation for when a delivery doesn’t go as planned.

How purchase orders work

Businesses large and small use purchase orders to simplify the purchasing process. Purchase orders are used by businesses to order goods. For example, a bakery might need to order flour and other ingredients in bulk from a supplier. They will use a purchase order to list how much flour and other ingredients they need, along with the price. The supplier will then take the purchase order, pull their inventory, and send the goods to the bakery. Once delivered, the supplier will send an invoice asking for payment.

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, sometimes, they might not have the items in stock that a buyer needs. Or they might not agree with the price point a buyer is asking. When this happens, the seller might ask the buyer to make revisions to their purchase order. Or, if changes can’t be made, the buyer will need to find a new seller.

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Purchase order numbers

Each purchase order comes with a unique PO number. PO numbers make it easy for both the buyer and the seller to keep track of delivery and payment. The PO number allows buyers to track their order throughout the entire procurement process. This way, the buyer can ensure they receive the right items or services requested.

Most small businesses start by tracking their purchase orders in Microsoft Excel templates or purchase order templates. However, electronic purchase orders make the purchasing process much easier. With QuickBooks Purchase Orders, you can track purchase transactions and PO numbers, and keep inventory moving.

Purchase order example

Purchase orders look very similar to invoices. You’ll find contact information, the date, and the PO number at the top of a purchase order. A table below will list the products, quantities, and prices for the order in separate columns. At the bottom of the purchase order will be the total order amount, the total price, and space for an authorized signature.

The image below shows an example of a purchase order:

Example of purchase order

Purchase order procedure: Next steps after purchase orders

Once a purchase order is sent to a vendor, you’re probably wondering what happens next. Below are the steps that take before, during, and after purchase orders:

  • Step 1: Buyer completes a purchase requisition: Before sending a purchase order, a buyer first needs to figure out what and how much they need to buy. A purchase requisition is a document that the purchasing department typically fills out. This document allows companies to track their expenses and keep tabs on the items or services they ordered.
  • Step 2: Buyer drafts a purchase order: Once it’s determined what items or services need to be ordered, a company creates a purchase order form. The purchase order will include contact information, the date, number of items being purchased, each item’s price, quantity, and PO number.
  • Step 3: Vendor accepts or rejects the purchase order:  The vendor has the option to either accept or reject the purchase order. Once the seller accepts and signs the purchase order, it becomes a legally binding contract. If it’s rejected, the seller might ask the buyer to make revisions, or the buyer might have to find a new vendor.
  • Step 4: Seller fulfills the order: Once the seller accepts the purchase order request, they will begin fulfilling the order by taking out the correct inventory or scheduling the right staff.
  • Step 5: Seller delivers order and provides invoice:  The seller then delivers the products or services to the buyer, along with packing slips to keep track of what was delivered. Along with the delivery, the seller provides an invoice with the appropriate PO number to match the delivery information.
  • Step 6: Buyer makes payment: After reviewing the invoice, the buyer will then pay for the products or services they received. The payment should already have been agreed upon between the buyer and seller in the purchase order.

Wrapping up

Purchase orders are a great tool for record keeping, as they document the goods and services a buyer needs from a vendor. Companies use purchase orders to send order details to a supplier to ensure they receive the right products or services by an expected delivery date. Purchase orders also help with inventory management, as they allow companies to see what inventory may be running low and needs to be filled.

Creating a purchase order is simple, especially when using an electronic purchase order system. With QuickBooks Online and QuickBooks Payments, you can manage orders and invoices, accept payments like credit cards, and more. Learn how QuickBooks can help your small business today.

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