What Is a Purchase Order & How Do They Work?
As a 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 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, also known as PO, is a legally binding document issued by a buyer to a seller, specifying requested products or services at a mutually agreed upon price. 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. In short, it sets very clear guidelines of the agreement in advance so both parties can know clearly what to expect.
A purchase order 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. Because the order is fulfilled before the buyer receives their bill, a purchase order gives the seller insurance against non-payment.
How Does a Purchase Order Work?
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:
The shop owner notices they are low on inventory.
The shop owner creates a purchase order laying out exactly what they need from the supplier, and how much they will pay for it.
The supplier responds “yes,” because they can provide those items, and accepts the order.
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.
The supplier fulfills the order and delivers the items on the agreed due date.
The supplier issues a bill or sales invoice for the purchased items.
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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Benefits of Using Purchase Orders
Purchase orders offer several benefits for both buyers and sellers. Here's how they help:
For the buyer:
Track inventory and purchase history efficiently.
Order goods in advance without requiring immediate payment.
Better manage a budget by ensuring the purchase lines up with available funds
For the seller:
Simplify inventory management and track recurring orders.
Provide legal security and ensure the buyer is committed to payment once the order is fulfilled.
Build more meaningful relationships with customers by having detailed ordering information readily available
What Does a Purchase Order Look Like?
Purchase orders also look very similar to invoices–at the top, you have the contact information and details for each company, plus the PO number and date. Below that information is generally a table with the products, quantities, details and prices in separate columns. At the bottom of the purchase order, you’ll place the total order amount, the total price and any other order or payment terms along with an authorized signature.
How to Create a Purchase Order
Business owners can find online software to help create purchase orders, but you can also use a simple Word or Excel document to make your own order forms instead. Here’s what you’ll need to include:
Issue date
Products needed and the quantity of each product
Total number of products required
Product details including SKU numbers, model numbers and brand names
Price of each product per unit
Discount codes
Delivery date
PO number
Business information including the shipping and billing address, company name and contact information
Terms for payment, such as “paid upon delivery” or specific payment date options
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.
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