Purchase orders are used by buyers to provide product/goods details to the sellers. A purchase order serves as a communication document to process the goods purchased.
It offers several benefits to both parties including financial record management, inventory management, and payment terms.
Let us discuss how a purchase order works.
What is a Purchase Order?
A purchase order is an official document that a buyer uses to place an order with its vendors and suppliers.
The purchase order form includes several useful information points including the date, items ordered quantity, pricing, and payment details.
A purchase order (PO) is a confirmation from the buyer for the supplier. Once received, the supplier can start manufacturing products. The purchase order offers a binding contract to both parties to pursue the trade contract terms for the manufacturing and shipment of the products.
For buyers, the purchase order is an effective document to keep purchases records as well as maintain adequate inventory levels. It helps buyers in fulfilling their inventory demands without keeping exaggerated stocks.
In short, purchase orders can be considered a form of purchase contract between the buyers and vendors. These order forms can be created as printed documents or sent through online mediums such as using an ERP system.
What Information is Included in a Purchase Order?
A purchase order precisely includes all relevant points regarding the purchase of products.
Let us list a few key points to be included in a purchase order.
The date at which the order is created. This date can be used as a reference for future correspondence along with the order number.
Purchase Order Number
It is a unique number assigned to each order. It acts as a unique document identifier for both the buyer and the seller.
The PO number is used for references in several other documents such as invoices, shipping documents, and billing orders as well. Thus, it must be a unique number and kept accurately to avoid any duplication or loss of valuable data.
Vendor Contact Information
This section includes supplier or vendor contact information. It can include the vendor’s complete company name, address, and email address.
This section must include complete details about the product. It indicates product size, quantity, labeling, or serial numbers. The purpose of this section is to order the right products in the right quantity.
Each product can have different pricing. Also, this section can include wholesale and retail pricing information for the convenience of both parties.
The prices are agreed upon by both parties when making product inquiries. The formal pricing is adjusted when the purchase contract is finalized.
This section can include any specific instructions such as the billing terms or price discounts as applicable. However, it can include only brief instructions regarding the purchase order only.
The buyer and seller may have different tax compliance requirements. For instance, this section can include the VAT charge or the reverse VAT charge depending on the agreement between both parties.
It can be a formal section that includes the billing and shipping address of the buyer.
Delivery terms such as the products should be delivered within 30 days with the same prices can be included in this section.
Format of a Purchase Order
Although a business can use any purchase order format there are a few sections that are usually included as a standard formatting guide.
This section should include information like the buyer’s company name, business address, purchase order number, and date, etc.
The header section may include the subject or type of order as well.
This section includes vendor information. These points may include the vendor’s business name, business address, contact number, and so on.
You can include the shipping address for purchased goods under this section. The shipping address of the purchased goods can be different from the business address of the buyer.
Under this section, you can include order specifications. These details can include product quantity, price per item, size guide, volume, and labeling instructions, etc.
The final section includes order price, discounts, tax information, and net purchase order total. The buyer can include any discount policy or tax information notes in this section.
Steps in a Purchase Order
The formal process of purchase order begins with a product inquiry by the buyer. There are a few prerequisites for both parties before they can proceed with the purchase order.
These preparation steps include inquiries on product prices, specifications, availability, and customization. Once both parties enter into a formal contract, they can proceed with the purchase order.
Key steps involved in a purchase order are listed below.
The first step is to create the purchase requisition. The buyer identifies the products to buy with specifications and customized requirements.
Draft Purchase Order
The buyer creates a draft of the purchase order. It is reviewed by the purchasing department internally. The PO is sent to the seller with a unique PO number.
Review of Purchase Order
The seller reviews the PO requirements such as the product quality, quantity, customization, and delivery time.
The seller can request amendments in this step from the buyer.
Approval and Processing
Once both parties agree on the terms, the seller starts processing the order. The PO remains open during the processing.
The seller can create the order invoice near the order completion date as well. However, the payment terms will decide when and how the buyer will pay.
Pros and Cons of Using a Purchase Order
A purchase order offers several benefits to the buyer and seller at the same time.
Improved Financial Records
Both parties can improve their financial records by using purchase order forms. It will help them identify costs, improve budgeting, and timely financial decisions.
Help in Inventory Management
Both parties can keep adequate inventory levels with the help of purchase orders. The buyer can tally inventory levels with the ordered goods and plan accordingly.
The seller receives legal protection against the non-payment of the buyer. Similarly, the buyer can avoid any overpayment or claims of non-payment.
Improved Payment System
Importantly, purchase orders help sellers collect payments quickly. They can keep a record of buyers’ payments and pursue them accordingly.
Purchase orders have some limitations as well.
Setting up a purchase order system requires comprehensive role designations. The process can be lengthy and cumbersome to manage for a small business.
Costly for Small Businesses
A proper PO management system can be costly for many small businesses. Most PO management systems are now embedded in ERP systems that come at a higher cost.
Purchase Order v Work Order
The primary difference between the work and purchase order is the nature of the contract. A purchase order is for the purchase of goods or products whereas a work order is for the services rendered or required by a business.
Work orders include similar information. A work order must include important information such as work details, cost, timeframe, and payment schedule.
The sequence of events and processing happens similarly for a purchase and work order. Both parties can take similar advantages by using a work order as with a purchase order.
Purchase Order v Invoice
The purchase order specifies the purchase requirements of a buyer. It is a binding document for both parties. The seller needs to supply the goods as per the terms and conditions approved in the purchase order.
On the other hand, an invoice is a document that details the payment terms. It shows how much a buyer needs to pay for the purchased goods or services.