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What Is a Purchase Order & How Does It Work?

As a small business owner, tracking your inventory and ordering supplies and sellable goods may not be your favorite task, but it’s certainly essential for the success of your company. Purchase orders are essential for a well-managed purchasing process, but many businessmen and women don’t understand what they actually are, or how to use them for financial success.

In this article, we’ll cover:

  • What a purchase order is

  • What you need to include in a purchase order

  • The difference between a purchase order and an invoice

What is a Purchase Order

A purchase order (PO) is a legally binding document created by a buyer and presented to a seller. Much like your “cart” on an e-commerce site, a purchase order is essentially a list of what you want to buy. It lays out the order details, including quantity and types of products the buyer needs, as well as payment terms and delivery details.

The difference between a purchase requisition and a purchase order is that the latter acts as a contract between the buyer and the seller. By submitting an order, the buyer is committing to purchasing goods or services for the agreed upon amount. Since the order is filled before the buyer receives their bill, a purchase order gives the seller insurance against non-payment.

How Does a Purchase Order Work?

Warehouse worker tracking inventory on a tablet

Purchase orders are usually used by small businesses who are ordering goods in large quantities. For example, a pet shop may need to buy several types of dog food from a supplier, and order many bags of each type of food. Here’s the purchase order process the pet shop owner would use to get the goods they need:

  1. The shop owner notices they are low on inventory.

  2. The shop owner creates a purchase order laying out exactly what they need from the supplier, and how much they will pay for it.

  3. The supplier responds “yes,” because they can provide those items, and accepts the order.

  4. The supplier could respond “No,” if they are out of stock, an item has been discontinued or there are other issues with the order, in which case the purchase order is canceled.

  5. The supplier fulfills the order and delivers the items on the agreed due date.

  6. The supplier issues a bill or sales invoice for the purchased items.

  7. The buyer pays for the item, and the sale is processed through the seller’s POS system.

Buyers can also create special orders for especially large shipments or recurring purchases. A standing purchase order allows a buyer to purchase the same products many times over using the same PO number. A blanket purchase order is an agreement between both parties for multiple deliveries over a set period, for a set price. Blanket orders are usually used between companies with a strong relationship, and sometimes come with discounts or other incentives.


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The Difference Between a Purchase Order and an Invoice

Because purchase orders and invoices are both legally binding financial documents that are exchanged between sellers and buyers, it’s not surprising that the two are often mixed up. The two are also connected because a purchase order is often used to create an invoice, as a reference for the goods purchased and their prices. However, each document is used at a different point in the buying process, and they are used by different people as well.

Here’s a quick list of differences buyers and sellers need to know:

Purchase Order

  • Created by the buyer

  • Created before purchase

  • Lays out goods needed

  • Includes proposed payment details

Invoice

  • Created by the seller

  • Created after purchase

  • Confirms goods delivered

  • Requires payment on a specific date

When to Use a Purchase Order vs. an Invoice

A purchase order is used by a buyer to place an order and is issued before delivery.

An invoice is issued by a seller using invoicing software after an order is delivered. It defines the amount the buyer owes for the purchased goods and the date by which the buyer needs to pay.

How to Create a Purchase Order

There is a plethora of software available online to help you create purchase orders, but you can also use a simple Word or Excel document to make your own order forms! Here’s what you’ll need to include:

  1. Date of issue

  2. Products needed + the quantity of each product

  3. Product details, including SKU numbers, model numbers and brand names

  4. The price for each product per unit

  5. Delivery date

  6. PO number

  7. Business information, including

    1. Shipping address & billing address

    2. Company name

    3. Contact information

  8. Terms for payment, such as “paid upon delivery” or specific payment date options.

What Does a Purchase Order Look Like?

closeup of a purchase order template

In the end, a purchase order looks very similar to an invoice, which is yet another reason the terms are often confused. At the top, you have the contact information and details for each company, plus the PO number and date. Below that is generally a table, with the products, quantities, details, and prices in separate columns. And at the bottom, you’ll place the total order amount, the total price and any other order or payment terms, along with an authorized signature.

Benefits of Using Purchase Orders

For the Buyer:

  • Track your inventory and purchase history

  • Order goods in specific amounts and in advance

  • Choose the delivery date you need

  • You don’t have to pay in advance

For the Seller:

  • Track sales and recurring orders

  • You can use a PO to create your invoice

  • Commits the buyer to paying, giving you legal security

Getting Started with Purchase Orders

We hope you’ve found this guide helpful, and that you have a better understanding of what a purchase order is and why it’s so important. When used properly, purchase orders can help you track your supply needs and make smart financial decisions for your business. This, in combination with other good business practices, helps you create a path towards success!

Want to learn more about important business finance terms? Check out our posts on Pro Forma Invoices, Credit Card Processing Fees and Straight Line Depreciation.

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Lindsey McGee Headshot

Lindsey McGee