What Is a Purchase Order?

A purchase order (PO) is a commercial document issued by a buyer to a seller, indicating types, quantities, and agreed prices for products or services. It is the first official offer issued by a buyer to a seller, showing a commitment to pay for goods or services. The significance of a purchase order in business transactions cannot be overstated, as it serves to streamline the procurement process and ensure clear communication between the parties involved.

In this post, we will dive deep into the concept of purchase orders, why it is important, and the types of purchase orders. 

What Is the Purpose of Purchase Orders?

what is a purchase order?

In the world of business, clarity, and precision in transactions are not just beneficial; they are imperative. This is where purchase orders (POs) come into play, acting as the backbone of business dealings by offering a structured and legally binding agreement between buyers and sellers. But what exactly is the purpose of a purchase order, and why is it so crucial in business operations? Let’s dive deeper.

A Foundation for Clear Communication

At its core, a purchase order is a document issued by a buyer to a seller, detailing the products or services agreed upon and the price. It serves as a formal offer to purchase, outlining the specifics of what is being bought, in what quantity, and at what price. This clarity is invaluable as it sets the groundwork for clear communication, ensuring both parties are on the same page regarding the transaction’s details.

Legal Protection for Both Parties

One of the most significant advantages of using a purchase order is the legal protection it affords both buyers and sellers. Once the seller accepts a PO, it becomes a legally binding contract. This means that the seller is obligated to supply the products or services at the agreed prices and terms. Likewise, the buyer is legally bound to pay for the goods or services received. This mutual protection helps prevent misunderstandings and disputes, providing a solid legal framework for recourse should issues arise.

Financial Planning and Budgeting

Purchase orders play a pivotal role in financial planning and budgeting. For businesses, being able to track outgoing expenses and anticipated costs is crucial for maintaining financial health. POs allow companies to monitor expenditures closely, as each order is documented and can be matched against invoices and receipts, ensuring that payments are made for goods actually received and at the agreed prices. This level of financial oversight is invaluable for budgeting purposes and financial forecasting.

Streamlining Procurement and Inventory Management

Effective procurement and inventory management are vital components of a successful business, and purchase orders contribute significantly to streamlining these processes. With POs, businesses can track their orders from placement to delivery, helping manage inventory levels more efficiently. This tracking ensures that stock levels are maintained appropriately, reducing the risk of overstocking or stockouts, which can be costly.

Facilitating Order Accuracy and Vendor Accountability

Purchase orders detail precisely what has been ordered, including the quantity, specifications, and delivery expectations. This level of detail helps ensure order accuracy, reducing the likelihood of errors in delivery. It also holds vendors accountable for providing the goods or services as specified, within the agreed timeframe. Should discrepancies arise, the PO serves as a reference point for resolving issues, helping maintain strong buyer-supplier relationships.

Components of a Purchase Order

A standard purchase order includes:

  • A unique purchase order number for tracking.
  • Detailed descriptions of the requested goods or services.
  • Quantity and price of each item.
  • Specified delivery date.
  • Billing and shipping details.
  • Terms and conditions outlining payment terms and delivery specifics.

The Different Types of Purchase Orders

Understanding the different types of purchase orders can help businesses manage their procurement processes more effectively and efficiently. In this section of the post, we will explore the 4 major types of purchase orders, namely: Standard, Planned, Blanket, and Contract purchase orders. 

Standard Purchase Orders

Standard Purchase Orders are the most common type. They are used for one-time purchases when the details about the goods, services, quantity, and price are known upfront. These POs are straightforward: a business identifies a need, finds a supplier, agrees on the price, and issues a PO. Standard POs are ideal for routine transactions where the specifications and vendor conditions are clear and unlikely to change.

Ideal for: Single transactions with defined requirements.

Planned Purchase Orders

Planned Purchase Orders are used when a business anticipates a need for goods or services over a period but may not know all the details upfront. These POs outline the types of items, the estimated quantities, and the delivery schedules but leave specific details, such as exact delivery dates and sometimes exact quantities, to be confirmed later. Planned POs are a way to lock in pricing and terms with a vendor while maintaining flexibility in delivery.

Ideal for: Long-term needs with flexible delivery schedules.

Blanket Purchase Orders

Blanket Purchase Orders are similar to planned POs but are used for more extended periods. They establish a pre-arranged agreement with a vendor for multiple deliveries over a time frame, typically at negotiated prices. The specific quantities and delivery dates are not specified in the PO and are determined as orders are placed against the blanket PO. This type of PO reduces the administrative burden of issuing multiple standard POs and is beneficial for items that a company purchases regularly.

Ideal for: Recurring purchases with negotiated terms.

Contract Purchase Orders

Contract Purchase Orders, also known as framework agreements, are less about the immediate procurement of goods and services and more about setting the terms and conditions for future transactions. These POs do not specify quantities or prices but lay out the terms of engagement, quality standards, pricing models, and delivery expectations. Contract POs are used to establish a long-term relationship with a vendor, and standard POs are issued against them as specific needs arise.

Ideal for: Establishing long-term vendor agreements.

The Purchase Order Process: A Step-by-Step Guide

what are purchase orders

To create and utilize a purchase order, here are the steps to follow:

Step 1: Identifying the Need

The process begins with the identification of a need within an organization. This could be anything from office supplies to large-scale machinery. The key here is understanding precisely what is required, in what quantity, and by when it is needed.

Step 2: Vendor Selection

Once the need is identified, the next step is to find a vendor that can supply the required goods or services. This step may involve requesting quotes from multiple suppliers, evaluating their offers, and negotiating terms.

Step 3: Creating the Purchase Order

After selecting a vendor, the next step is to create the purchase order. This document should include detailed information about the order, such as:

  • Purchase order number for tracking.
  • Detailed description of the goods or services.
  • Quantity and price.
  • Delivery date.
  • Billing and shipping details.
  • Any other terms and conditions.

Step 4: Approval Process

Before the purchase order is sent to the vendor, it often needs to be approved internally. The approval process varies from company to company but typically involves review by the finance or procurement department to ensure the purchase aligns with the budget and company policies.

Step 5: Sending the Purchase Order

Once approved, the purchase order is sent to the vendor. This acts as an official offer to buy the products or services under the specified terms.

Step 6: Vendor Acceptance

Upon receiving the PO, the vendor can either accept, reject, or negotiate the terms of the order. Acceptance of the PO creates a contract between the buyer and seller.

Step 7: Fulfillment

After acceptance, the vendor prepares and ships the ordered goods or provides the services. The vendor must meet the quality and timelines agreed upon in the purchase order.

Step 8: Receiving and Inspection

Upon receiving the goods or services, the buyer should inspect them to ensure they meet the specified requirements. Any discrepancies should be addressed immediately with the vendor.

Step 9: Invoice and Payment

After the goods or services are accepted, the vendor sends an invoice, which should match the details of the purchase order. The buyer then processes payment according to the agreed terms.

Step 10: Record Keeping

Finally, both parties should maintain records of the purchase order, delivery, invoice, and payment for future reference and auditing purposes.

Conclusion

Purchase orders play a critical role in business transactions, providing a foundation for clear communication, legal protection, and financial management. Their importance in ensuring smooth and transparent procurement processes cannot be overstated.

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