What Is a Purchase Order?

When you start a business, you might be surprised at the number of documents you need to generate and manage just to complete a transaction. Invoices, receipts, purchase orders, and more all have their unique functions. However, what role does each document play and how do you use them properly in your own business accounting functions?

In this article, we’re diving into everything you need to know about purchase orders. We’ll explain inbound purchase orders when you need to fulfill an order. We’ll also cover outbound purchase orders when you need to secure inventory.

Let’s get started.

What Is a Purchase Order?

Purchase orders are commercial documents created by the buyer and sent to the seller. This document is a formal request to purchase products or services. On a purchase order, the buyer will indicate the requested product or service, quantities, and the agreed-upon price point.

What Is a Purchase Order Used For?

Yes, a purchase order’s primary function is to place an order with a vendor. However, purchase orders also fulfill other essential services, whether you are creating or receiving them:

Document the Agreement

When you place an order over the phone, there’s always a chance that something is miscommunicated or there’s a clerical error. When a buyer documents the products or services they’re requesting on paper—via a purchase order—this ensures that the seller understands what items they need to supply. Also, a purchase order ensures that the buyer understands the payment terms.

If anything goes awry, you can always refer back to the purchase order to see what the buyer and seller agreed upon.

Quickly Reference Orders

Each purchase order should be assigned a purchase order number (PO number). This reference number makes it easy to track active orders. If one party needs to contact the other party with a question, you should be able to quickly access the purchase order using this number. 

Legally Binding

Both purchase orders and invoices are legally binding contracts. Once a seller accepts a purchase order, they are legally obligated to deliver the requested items. Similarly, the customer must oblige with the payment terms, whether it’s due upfront, on receipt of the items, or even a payment installment plan.

Avoid Fulfillment Errors

When the supplier receives a purchase order, they understand what needs to be shipped and when it must be delivered by. An itemized list of the buyer’s requested items can help to avoid costly errors and improve operational efficiency.

Helps You Create Your Business Budget

When your business is sending purchase orders, whether to secure inventory or restock office supplies, you can use that information when you create your business budget. Reviewing past purchase orders that you’ve sent out can help you predict your monthly business expenses. This will help track your business spending and identify savings opportunities.

Buyers Can Pay Later

Depending on the buyer-seller agreement, a seller can fulfill a purchase order without receiving payment in advance. Rather, the payment is delayed after the shipment is received and inspected. After confirming receipt of the product or service, the seller can send an invoice to collect the outstanding balance.

Update Inventory

For vendors, purchase orders are essential for updating inventory. With purchase orders, the vendor can determine whether they can fulfill an order or if they must cancel or delay it. Also, when inventory is pulled and shipped, records can be regularly updated for improved inventory accuracy.

Financing Solution for Small Businesses

If you’re struggling with securing inventory to fulfill your purchase orders, you can look into purchase order financing. A purchase order financing company will cover the manufacturing and delivery costs of your orders and will accept payment directly from your customers. They subtract their fees from the payment and forward you the remaining payment.

Purchase order financing is easy to qualify for, as purchase order lenders are more concerned with your customer’s credit history than yours. This makes it an attractive option for startups. However, the lender fees can be high and financing isn’t available to service-based businesses (you must sell a physical product).

What Does a Purchase Order Include?

If you’ve ever reviewed an invoice, you might notice that a purchase order contains many of the same items:

  • Purchase order number
  • Buyer’s information (company name, shipping and billing address)
  • Vendor’s information (company name, shipping and billing address)
  • Itemized list of requested items
  • SKUs and model numbers
  • Quantities and price
  • Payment terms
  • Cancellation policy

Here is an example of a purchase order template:

what is a purchase order

Why Are Purchase Orders and Invoices Both Necessary?

Since purchase orders and invoices are so similar, you might be wondering whether both are necessary. An invoice could still be required in certain scenarios, especially if payment is not issued upfront.

For example, let’s say a company creates a purchase order for new desks. The desk company reviews the purchase order and accepts it. However, the payment terms specify that payment will be issued upon receipt of the shipment. Once the shipment is delivered, the desk company can send an invoice to collect payment.

Purchase Requisition vs. Purchase Orders

If you’ve been researching purchase orders, you might have stumbled across the term “purchase requisition.” Both purchase requisitions and purchase orders are tied together but one occurs before the other.

Remember that business owners also create their own purchase orders when securing inventory. If you have employees and operate out of an office space, you will need to regularly restock office supplies such as paper, coffee grounds, and toiletries. When this happens, you should have a purchase requisition system in place.

However, a purchase requisition form should be submitted before sending a purchase order. This is an in-house procedure where the appropriate employee makes a request and whoever is in charge of purchasing approves or denies the request.

For example, office administrators may make a formal request for another copy machine because there’s always a long line. They will fill out a purchase requisition form and then forward it to the purchasing department. 

If the purchase requisition is approved, you can move into the purchase order phase. You can price shop among different suppliers to determine who can best fulfill your purchase order. Once you find a vendor, you can work out the details of fulfilling your purchase order.

It may be helpful to note that purchase requisition is an internal process. When you finally make a formal request to an outside vendor, then you’re sending a purchase order.

what is a purchase order

How to Track Purchase Orders

There are two ways to track your purchase order: on paper or electronically. 

Purchase Order Books

You’ve probably encountered this type of book if you’ve been in business for a while. Each order form has two copies: a white original followed by canary duplicates (often yellow). When you write on the white original, the ink is transferred to the following yellow pages. The yellow copies are then distributed among the relevant parties, usually the buyer and shipping department.

Some businesses still operate by paper, but we do not recommend this route. Since you must manually transfer the purchase order details into the book, you risk human errors. Chances are, you’ll probably want to save an electronic copy anyway. It’s usually more efficient and environmentally friendly to go digital with purchase order software.

Purchase Order Software 

Gone are the days when you need to buy a huge filing cabinet just to organize and store the mountain of paperwork you accumulate over the years. Increase your efficiency and reduce your carbon footprint by going digital. An electronic system helps you better create and process your purchase orders and can increase efficiency, save money, and keep your customers happy.

Recommended Purchase Order Software

If you’re ready to go digital with your purchase orders, these options will help you create and send professional documents.

Procurify

If you’re a medium or large company processing around 1,000 purchase orders per month, then Procurify is a great option to consider. With their software, you can manage purchase requisitions, create purchase orders, and process invoices.

Unfortunately, Procurify doesn’t offer any pricing options on their website. You must contact their team directly and request a quote. However, you can sign up for a free demo to test their software before committing to it.

Spendwise

Spendwise helps you save time and money by streamlining the purchasing, receiving, and billing operations of your business. With their web-based software, you can create professional purchase orders in seconds.

A glowing pro about Spendwise is that they list their pricing on their page. Their basic plan starts at just $9 per month. Like Procurify, you can sign up for a free trial to test their software. This makes Spendwise an affordable option for lean startups.

The Final Word

Sorting and understanding all the documents that flow in and out of your business can get confusing. Purchase orders, especially, are something you want to get familiar with. Better understanding purchase orders will help you fulfill incoming orders. Also, you better negotiate terms when sending your own purchase orders. Hopefully, you walk away from this article with an actionable tip or two on how to improve the purchase order process within your own business.

Founding Editor and VP at Fundera at Fundera

Meredith Wood

Meredith Wood is the founding editor of the Fundera Ledger and a vice president at Fundera. 

Meredith launched the Fundera Ledger in 2014. She has specialized in financial advice for small business owners for almost a decade. Meredith is frequently sought out for her expertise in small business lending and financial management.

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