What are purchase orders and how do they work?

When a business enters into a buying or selling agreement, both businesses must ensure they are protected within that transaction. The entity that is purchasing goods or services needs some sort of guarantee that they’ll receive the items they are purchasing, and on the other side, the seller is looking for assurance that they’ll receive the payment from the buyer.

These types of transactions take place in every business across all different industries. It could be that a manufacturing plant is purchasing raw materials or a retail store is buying a new set of merchandise. Prior to completing the sale – ie sending goods or offering services – getting a purchase order in place offers peace of mind to businesses on both sides of the transaction.

As a contractual agreement, a purchase order is a standard part of most business transactions today. Without one, both parties could end up in vulnerable positions, so it’s best for everyone involved to prioritize purchase orders. If you’re not yet using this practice within your organization, don’t sweat it. We’ll tell you everything you need to know about using a PO, how to integrate it into your business practices, and how technology can make your purchase orders even easier. Keep reading if you want the following questions answered:

• What is a purchase order / what is a PO?
• What is the purchase order definition?
• What is a purchase order use case?
• How do I fill out purchase orders?
• What are the different types of purchase orders and when are they used?
• How can technology simplify the PO process?

What is a Purchase Order?

From a technical perspective, the purchase order definition is a contractual agreement between buyers and sellers that details the specific items being sold, the quantity of goods or services, the price for the transaction, and the two businesses involved. Using a purchase order – often called a PO – for all transactions is in the best interest of buyers and sellers.

The first step in healthy vendor relationship management, purchase orders should be thought of as a tool. They go further than offering legal protections in the event of a deal going south; they also are referred to and relied on for organizational purposes. When warehousing teams have visibility to incoming POs, they can better manage inventory and production planning. When purchasing teams can track outstanding POs, they can help their organization avoid duplicate purchases or chase down late orders. 

To reap the benefits from purchase orders, it’s important to establish a routine process with how they are filled out, approved, and tracked. There are many tools available to businesses today to make purchase orders a breeze, but before implementing technology, focus on getting the basics of a PO down.

How Does a Purchase Order Work?

Before you send a purchase order off to a vendor or supplier, it should consist of detailed and accurate information. Standardizing your purchase order form will help ensure that all POs have the necessary information included and that they can be filled out with ease every time. Every purchase order should have the following data clearly listed:

• Product or service information (description, SKUs, price, quantity)
• Purchase order number
• Date of purchase order
• Delivery date
• Vendor’s company name and contact information
• Buyer’s company name and contact information
• Billing address
• Shipping address
• Payment terms
• Legal requirements
• Sales tax information
• Invoice total

If you make a lot of international purchases with POs, you may need to include customs information or additional details for international shipping. Be sure to check with the vendor and local immigration office. Purchase orders don’t have to be overly complex or fancy; they simply need to be functional, consistent, and applicable to your needs.

Once you have correctly filled out a purchase order, the purchasing process can begin.

Understanding the Role of POs in the Purchasing Process

Before your purchasing team buys something from a supplier or vendor, they may have a conversation with the vendor team and agree on preliminary pricing or other parameters. At that point, a PO should be filled out to initiate the purchasing process. The cycle every PO will go through is as follows:

1. Decide to buy: As a buyer, you’ll make a decision to place an order for a product or service. Figure out how much of said product or service you want, and when you need it. If you need more wood to build products for a holiday surge, be sure to figure out when you’ll need the wood.
2. Draw up the PO: Fill out the purchase order with the information listed above.
3. Send the PO: Once it’s ready, send the purchase order to the seller for review. At this point, they’ll decide whether or not they can fulfill your needs within the delivery timeline requested.
4. Seller approval: If your vendor can fulfill the order, they’ll approve the purchase order. Once a PO is approved by the seller, it becomes legally binding for you and them.
5. Order completion: The vendor is legally obligated to get you the goods or services by the agreed-upon date. You will likely receive an invoice from the seller during this time; either before or after the order is fulfilled. Before paying the invoice, rely on your AP internal controls to verify that the invoice is accurate.
6. Pay invoice: After you have completed three-way matching to verify that the PO matches the invoice, and both align with the goods or services received, you can send the invoice for approval. Once approved, the invoice should be paid. Try to pay invoices early if they have an early payment discount clause, this will save you money, and every dollar counts! If you want to optimize the supplier payment process, this is a great place to start.
7. Close the PO in your system: This final step helps keep things organized in your PO system. If a PO is left open after the invoice has been paid, your AP team could accidentally send duplicate payments.

What is the Difference between Purchase Orders and Invoices?

Although purchase orders and invoices are critical parts of the purchasing process, they are NOT the same thing. As detailed by the steps above, purchase orders come earlier in the process than invoices. An invoice is created by a vendor in response to a purchase order. Additionally, the buyer is responsible for filling out and sending the PO, while the seller is in charge of sending and monitoring the invoice. If you find yourself still asking, “What is a purchase order?” read this.

What are the Different Types of Purchase Orders?

At its core, the purchase order definition stays more or less the same, but there are different types of purchase orders that are best used in certain situations. Each one requires slightly different information, so be sure to know the type of PO you’re using in each purchasing process.

Standard Purchase Orders

When answering the question, “What is a PO?” the standard purchase order is going to be the most classic. These purchase orders are used in many situations and for many types of transactions. If you’re just buying a one-off item or purchasing goods for the first time from a new vendor, you can’t go wrong with a standard purchase order.

Planned Purchase Orders

If you know you’ll need certain goods or services in the future, filling out a planned purchase order can save time in the long run and help the vendor ensure they have the inventory needed to fulfill orders that are months down the line. Price, payment terms, and the products are established, but delivery timelines or amounts may be slightly adjusted as the date gets closer. This is great for planning but still offers some flexibility on both sides.

Blanket Purchase Orders

After finding out the answer to “What is a PO?” the next question you should be asking is, “How can I get a discount?” The answer is a blanket purchase order. If you commit to buying a larger quantity, the vendor may offer a bulk order discount. Although you’ll be contractually on the hook for a chunk of change, you’ll save money overall.  

Contract Purchase Orders

Adding another layer of legal protection and security for buyers and sellers, a contract purchase order puts a legal agreement in place before a purchase order is created. These may be used to lock in pricing in future POs, or simply to create clean legal boundaries before sending a binding standard PO to the vendor.

Digital Purchase Orders

More and more common today, digital purchase orders (DPO) are purchase orders sent through an automated purchasing system. If you’re looking to go paperless, or want to automate manual purchase order processes, these are a great option.

Automating Purchase Order Systems

If digital purchase orders sound enticing, it may be worth looking into purchase order systems that can bring your purchasing process into the digital age. Often, PO automation, automated approval flows, and easy matching capabilities can be found in AP software tools. At Nanonets, we created an AP automation software that revolutionizes the purchasing process, but it doesn’t stop there.

Within the finance and accounting functions, there is so much room for automation and digital transformation. Once your organization successfully implements and begins utilizing one of these solutions, you’ll see a massive change in how your teams operate. Suddenly, productivity will increase, work/life balance won’t be so hard to achieve, and employee satisfaction will shoot up. Investing in digital solutions today will position you for a better future tomorrow.

What is a PO? Now you Know!

Purchase orders are widely used between industries, regions, and businesses. Because of the legal protection they offer for organizations all over the world, using them is a no-brainer. Be sure to fill out all the information needed before sending a PO to your vendors. There are many free PO templates available if you’re not sure where to start. When you’re ready to uplevel your purchasing process, find the right digital accounting solution for your business.