Everything to Know About Purchase Orders

Purchase Orders
March 19, 2021
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If you’re starting a new business, there’s a lot to know on the financial and accounting side. Having the right software and technology can help solve many problems that could otherwise arise when it comes to accounting in a small business. For example, a comprehensive accounts payable solution like DataServ will keep you on-time with your payments and help you develop good relationships with your suppliers.

Even though technology can automate a lot of the heavy lifting for you, it’s still good to understand at least the basics if you’re starting a business.

Purchase orders are a good starting point but can often lead to confusion. The following is a guide to everything you need to know about purchase orders in your business, how they’re used, and what they’re not.

The Basics of a Purchase Order

A purchase order is something that’s sent from a buyer to a vendor to confirm the purchase of services or goods.

A buyer issues a purchase order. The buyer wants to make sure they’re getting exactly what they want and what they ordered.

This contrasts with an invoice, which a vendor issues. The invoice is issued by a vendor to ensure they get paid for their good or services.

A purchase order details what the order should contain and when it’s expected to arrive. Depending on the parties involved and the specific good or service, it might include a number of items that the order will include, detailed item descriptions, payment terms, the price, and the date of purchase.

A vendor sends an invoice only once a purchase is approved.

With an invoice, a vendor will usually include a purchase order number from the original purchase order, so there’s assurance the information on both documents matches.

A sales order is something sent by vendors to a buyer to confirm a sale before an order is fulfilled, while a purchase order confirms purchase and is usually sent by the buyer to the vendor.

Another way to look at it is that a purchase order is a request for an order.

If a seller accepts a purchase order, this is considered a legally binding contract.

Purchase orders add steps to the overall buying process, but they can also alleviate some of the possible hiccups that can occur in a transaction. They also help increase the likelihood that the order fulfilled is complete and correct.

If there’s a situation where a buyer refuses payment when a good or service is delivered, the purchase order protects the seller, since the PO is considered a binding contract.

The Purchase Order Process

The purchase order (PO) process usually includes the following steps:

  • The PO is created when a buyer wants to purchase a product or service. The purchase order details what the buyer is requesting from the seller, with pricing and payment terms included.
  • Before a PO is sent, it has to be approved. Every company will have its own approval process that will outline who in the company has to approve it before it’s sent to the supplier. A lot of modern businesses will require purchase requisition first, which eliminates the need for approval and keeps the process faster and more efficient.
  • Once a PO is approved, it can be sent to the vendor. It’s an internal document that ends up being used by an accounting team upon receipt of the invoice as well.
  • When the seller or vendor receives the order, it’s a binding contract. That means the vendor has told the company it can fill the order.
  • The seller then ships the order, and it includes the PO number so that a buyer knows the order that has arrived.
  • The seller will also include an invoice, and the PO number should be included on the invoice.
  • Most companies use what’s called three-way matching to confirm that all the order details line up, including quantities and the pricing.
  • When the company has confirmed the order and is happy with it, they approve an invoice, and following payment terms they agreed to, they arrange a payment to go to the seller.

Who’s Responsible for Issuing a PO?

As was touched on, the buyer creates and issues the purchase order. Since you’re operating a small business, it may be you or your financial manager who issues it. In a larger company, the purchasing department or the procurement department will usually issue a PO.

The Upsides of Electronic POs

It can be a good idea to avoid using paper-based POs in your small business because that’s not efficient and can create more work. It also leaves more room for error.

When you manage the PO process electronically, you can have them all accessible in a centralized place, and it speeds up the approval process. It also helps with visibility, which is essential for budgeting.

Are There Pros and Cons of POs?

There up and downsides to using purchase orders in a business.

Pros of purchase orders include:

  • Helps avoid duplicate orders
  • Can help prevent surprise invoices, and you can track incoming orders
  • You can identify unexpected increases in price
  • Sometimes POs are needed for auditing requirements
  • POs help with budgeting
  • Can strengthen communication and relationships with vendors
  • They are legally binding documents

What about the downsides?

Purchase orders do create additional work and paperwork, so if you’re operating with a small team, which is often the case in small businesses, the additional workload can be frustrating. Also, you can use a credit card instead of a PO for record-keeping and documentation purposes.

Overall, whether or not your business uses purchase orders in any capacity depends on different factors like your industry and your needs, but having a clear understanding of how they work can make sure you don’t find yourself in an uncomfortable position.

A purchase order can help you be proactive rather than only reacting to the situations when they arise, and they can help you have more insight into your business spending.

With purchase orders, you also create a concrete trail if something goes wrong.

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