What is a Purchase Order? Everything You Need to Know
A purchase order, also known as a PO, is a simple document that can make a significant difference in your business’ operations and accounting processes. No matter the size of your business, implementing a system for using purchase orders will keep things organized, traceable, and may even help save you money in the long run.
So, what is a purchase order, exactly?
A purchase order is a document that a buyer, or purchaser, issues to their supplier (also called the vendor or seller) to indicate what products or services they wish to purchase, in which quantity, and at what price. A PO will also indicate the terms of the purchase, such as when the order is expected to be delivered and what the payment terms are.
A purchase order serves many functions at once. Firstly, it provides an internal document in a company of what has been ordered and at what price. Secondly, it alerts a vendor that their customer would like to place an order with them and gives them an opportunity to accept the order. Finally, it acts as a legally binding document between the buyer and the seller. This gives every party involved some peace of mind. The buyer can be confident that their supplier is bound to deliver their order within the agreed upon time frame, and the supplier can be confident that the buyer is bound to pay for the order according to the terms outlined in the PO.
Even though you might be able to get by without creating a system for issuing purchase orders, if your business is small, it’s never too early to start using them. They’re a great way to keep your spending organized and an important habit of getting into as your business grows, and it becomes more difficult to keep track of every order you make. Plus, many vendors will request that you send them a purchase order rather than just email them, so if you want to project professionalism, it’s wise to have a purchase order template you can use anytime.
What is the process of using a purchase order?
Implementing the use of purchase orders in your business will entail more than just creating a purchase order template for you or your staff to use. It’s also important to understand the process that is associated with the use of purchase orders, so that you can avoid confusion and get the most out of this useful document. Following these simple steps each time you create a new purchase order will prevent any hiccups:
- The purchaser, who may be you or someone else in your business which you have delegated this responsibility to, decides what product or service they want to buy. They should also know the pricing and lead time for this product or service. If they don’t have this information, they can contact the vendor to get it before putting together the PO.
- Fill out your purchase order template detailing all of the specifics of the order. We’ll get into the various sections you should include in your business’ PO template below.
- If there is someone in your company who has the final approval of purchase orders before they are sent out, the next step is to have them approve the PO before sending it out. If you’re a sole proprietor without staff, or if you handle all purchases yourself, this step wouldn’t apply to you. However, if your organization is large enough that you have multiple departments, you might want to have a department head approve all purchase orders in their department, while staying within your business’ budget.
- Send the purchase order to the supplier. If they do not approve the PO, find out why. Perhaps your pricing on the PO was incorrect, or they are low on stock for something you wish to order. If, for whatever reason, they can not fill your order, they will reject the PO. When this happens, you can move back to step 1 to create a purchase order they are able to fill. Most of the time, however, the supplier will approve the PO. At that point, it becomes a legally binding document.
- Once a purchase order is approved, the seller will prepare the order. That may mean pulling the stock that you ordered or scheduling time for a service you are purchasing. They have within the time allotted in the PO to deliver the order to you.
- When the vendor delivers the product or service outlined in the purchase order, they will issue you an invoice with a number corresponding to your original PO. This can be compared to the PO to make sure all the numbers, such as quantities and prices, match up between the two documents.
- Once the invoice is paid and the order is delivered, the PO can be marked “complete” and filed away, and the invoice can be marked “paid”.
Following these steps every time will result in far fewer unexpected expenses and incorrect orders for your business.
You may have noticed in step #6 that your supplier will issue you something called an invoice. Sometimes the words purchase order and invoice are incorrectly interchanged.
While a purchase order is issued by the purchaser to the vendor, an invoice goes in the other direction, from the vendor to the purchaser. An invoice is only sent once a PO is approved. The main purpose of a purchase order is to indicate the details of an order being placed, while the main function of an invoice is to indicate the amount owed. While it’s important to know the basics of invoicing as an entrepreneur, in your interaction with vendors you’ll be issuing purchase orders and receiving invoices.
I’m ready to create my purchase order template. What should I include?
Luckily, there are lots of great purchase order templates online that you can plug your own information into, so you don’t necessarily need to create one from scratch unless you want it to match your business branding. Take a look at a few purchase order examples online so that you can get a sense of how they’re usually laid out to be easy to read and understand. Then, when it comes time to creating your own purchase order form for your business or customizing a free downloadable template, make sure to include fields for all of the following sections:
- A PO number. This is an important part of your purchase order because it will help you keep all your orders organized and easy to refer back to. It will also be used by your vendor when they issue you an invoice and packing slip. You can refer to the PO number to easily match up the purchase order, invoice and packing slip to make sure everything matches and no errors have been made. This is called 3-way matching. You can come up with an alphanumeric system that makes it easy to create PO numbers. For example, you can have a four-letter code for each vendor, followed by 001 for your first order for them, 002 for the second, and so on.
- The date of your purchase order. This indicates when the order was sent in. It can also be a factor in determining the date you have to pay by, since your payment terms with your vendor may begin the day you place an order.
- The payment terms. These are typically agreed upon in advance. Often, for an initial order, you may have to pay upfront. For subsequent orders, you only have to pay for a portion up front and the balance on delivery, or you may even be given a longer period to pay. Having a history of meeting your payment terms on your POs, particularly with large vendors, can help you get access to business credit in the future.
- The delivery date. This should be based on the agreed-upon lead time for the product or service you are ordering.
- Your business name and shipping address. Make sure you don’t accidentally use your mailing address here if it differs, since this is the address your supplier will ship to.
- Your vendor’s business name and billing address.
- The shipping method and terms.
- For each item, the item name or SKU number, description, and the quantity you wish to purchase.
- The cost for each item
- The total for all line items, before tax
- The applicable tax
- The total including tax
You will most likely be issuing your POs electronically, making it easier than ever to plug in these fields and fire it off to your vendor.
Why bother with a PO when I can send an email?
While many businesses go the informal route when they’re just starting out, calling or emailing their vendors when they want to place an order, there are many reasons why it’s worth taking a little bit of time to create a PO template that you can use again and again and sticking with the steps outlined above each time you want to place an order for your business.
- Using POs helps you manage your budget. Assuming you have a document management system in place (and you should!), you can easily look at your past POs and have all spending visible in one place. Are you spending more in one area than you think you should? Or maybe you’re placing more small orders for something than you realized when you could consolidate them into a large order and bring down your cost. Using POs is an easy way to gather and analyze this information.
- POs may offer you legal protection. Since they are considered a legal document once approved, a PO can help you in the event that your supplier isn’t holding up their end of the bargain. Even if you just have a misunderstanding about something, it’s much easier to go over your PO with your vendor than to dig through old emails or try to recall conversations.
- You make things easier for your vendor. Your vendor will be grateful for an easy, streamlined ordering process. They won’t have to follow up with you for missing information before approving your order, because all the relevant details are there in the PO.
- It makes for easier accounting, especially if you have a bookkeeper or accountant apart from yourself who isn’t aware of every transaction made by your business. They won’t have to go digging for information on where funds went if they can simply refer to past POs.
- If you are audited, you’ll be grateful you used POs in your business. It is much easier for you and your auditor to look at your POs and match them up against invoices than to dig through old emails and receipts to try to make sense of business transactions that took place years ago.
Is there any reason I shouldn’t use purchase orders?
There are some business expenses that won’t necessarily be subject to purchase orders. For example, POs are not used for regular recurring expenses such as utilities. However, many of your business expenses can be captured by this single document.
As an entrepreneur, there are already so many different tasks you must juggle at once. Implementing a system for using purchase orders in your business is a small thing you can do that will really streamline your operations, and make accounting much easier.
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This article offers general information only and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or its affiliates.