Purchase orders: what they are and why they are important

Purchase orders (POs) play an important role in the purchasing process, serving as formal agreements between buyers and sellers for the purchase of goods or services. This article explores the significance of purchase orders in business operations, highlighting their purpose, key components, and the importance of issuing and tracking them. We’ll also discuss the different types of purchase orders and their specific applications. Let’s dive in.

A purchase order (PO) is a commercial document that is issued by a buyer to a seller, indicating the details of a proposed purchase. A PO is a formal agreement between a buyer and a seller for the purchase of goods or services.

Standard POs typically include the following information:

• Contact information of the buyer and the seller
•  A unique number for tracking and reference purposes, known as the PO number
• The date of issue
• A description of the products or services being purchased, including specifications, quantities, part numbers (if applicable), and any other relevant details.
• The unit price and total cost of products and services being purchased 
• The agreed-upon terms of payment, such as the payment method, due date, and any applicable discounts or penalties for early or late payment.
• Delivery address, expected delivery date or timeframe, shipping method, and any specific instructions or requirements.
• Any additional terms, conditions, or contractual obligations agreed upon by the buyer and seller, such as warranties, return policies, or legal clauses.
• The PO may require signatures from authorised representatives of both the buyer and the seller, confirming their agreement to the terms outlined in the document.

POs serve as a legally binding contract from the buyer to the seller, indicating the buyer's intention to make payment. This is important as it often requires the seller to fulfil the terms of the PO before receiving payment. By establishing a PO, the seller gains protection if the buyer refuses to pay since the document holds legal weight.

To foster positive relationships between buyers and sellers, it’s best to have comprehensive terms and conditions outlined in the purchase order. These terms should encompass various scenarios, including specific guidelines for cancelling a purchase order. Establishing clear boundaries assures transparency and ensures a harmonious business relationship.

Buyers generate POs to formally request goods or services, while sellers issue invoices to request payment against that PO.

The key distinctions:

Having a well-defined procurement process and tracking POs throughout that process provides visibility into spending. By implementing a PO system, you establish a comprehensive record of what’s being purchased, how often, and in what quantity. Analysing this data provides valuable insights. It enables you to effectively manage your business operations and identify potential areas for improvement.

When concerns arise about excessive spending in a particular department, having a record of the total amount spent and the responsible parties allows you to investigate any issues that might be affecting expenses. Furthermore, this information can be utilised to create budgets, as it offers an average spending record for products or services, providing predictability and more accurate budget forecasts.

A PO system ensures that invoices are paid only once and establishes a mechanism to verify the delivery of goods or services. Both the buyer and seller have transparency throughout the transaction, reducing the chances of misunderstandings or disputes. In the event of a disagreement or a change to the order, all parties can refer to the documented trail of information. Implementing a well-defined PO process enhances efficiency and minimises errors.

There are four main types of POs that are used in particular circumstances:

• Standard purchase orders are generally used for one-time purchases. This type of PO is used in scenarios where businesses are clear about purchase requirements. Standard POs facilitate efficient purchasing by clearly specifying the required items, quantities, prices, and delivery details. 
• Planned purchase orders are internal documents used to initiate discussions and gather information prior to finalising details for a formal PO with a supplier/vendor. Unlike other types of purchase orders, a planned PO is not sent to the supplier/vendor for fulfilment or invoicing. Once the details are finalised and the organisation is ready to proceed with the purchase, the planned PO is typically converted into a formal PO.
• Blanket purchase orders, also known as standing orders, are typically used for recurring purchases. This type of PO streamlines repetitive purchases by establishing a long-term agreement with suppliers that documents the quantities, pricing, and delivery schedule. Blanket POs eliminate the need for individual negotiations with suppliers.
• Contract purchase orders are ideal for complex projects or ongoing services. These POs outline the terms, conditions, and scope of work and are legally binding agreements between you and your suppliers. By clearly defining expectations and deliverables, contract POs ensure compliance, mitigate risks, and foster strong partnerships.

Manual PO management involves the traditional and labour-intensive process of creating, tracking, and managing purchase orders manually. This method relies on physical paperwork, phone calls, and emails to communicate with suppliers and to ensure that orders are placed and delivered accurately. It requires a considerable amount of time and effort from procurement teams, making it susceptible to human errors and delays. 

Automated PO management utilises software and technology to streamline and digitise the entire procurement process. With automated systems, POs can be generated, automatically routed to approvers, sent to suppliers, and tracked electronically. This eliminates the need for manual paperwork, speeds up the process, and reduces the chances of errors. 

This approach enables real-time visibility into the status of orders, improves efficiency, and allows for better inventory control and cost optimisation. Organisations can save time, reduce costs, and enhance overall operational effectiveness by automating purchase order management.

As we’ve covered in this article, purchase orders (POs) are vital to the purchasing process. They establish clear terms and conditions, protect both parties and ensure transparency. In addition, tracking POs provides valuable insights for managing operations and expenses. Businesses of all sizes should consider transitioning to automated PO management systems to save time, reduce costs, and improve efficiency.