What is a Purchase Order?

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“Do you have the P.O. number for that order?” 

It’s a question most of us have been asked at some point, usually on the phone with a vendor who’s trying to answer our questions about a recent purchase. Purchase orders, or P.O.’s, play a big role in organizing a company’s sales. They also make it easier for the purchaser to keep track of spending. So what exactly is the definition of a purchase order? 

A purchase order is a document that shows a company’s intent to purchase something from another company. If signed, it’s a legal agreement between these companies to fulfill their ends of the bargain (meaning the purchaser pays and the vendor delivers). 

Here’s how they’re put to use by businesses around the world. 

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How Purchase Orders Are Used

First up, purchase orders clear up any confusion about what is being ordered. They are intended to be very detailed documents that have all the information a vendor could possibly need to complete an order, thereby saving dozens of emails going back and forth and keeping important details from being lost in the process. A well-done purchase order answers all questions and keeps all relevant information in one well-organized location. 

This easy-to-follow paper trail could come in handy if your business ever comes under audit by the IRS. All the detail purchase orders provide can help them through the auditing process more easily than relying on receipts and invoices alone. 

Finally, a purchase order means protection. If you clearly outlined in your P.O. that you wanted to order 200 copies of The Velveteen Rabbit for your bookstore and you get 200 copies of Twilight, you should have no issues getting a refund. But if an error is ever questioned by the vendor, your purchase order provides an added layer of protection against their mistakes. That’s because, once signed, purchase orders are legally binding, which means the vendor must adhere to the terms you both signed off on. 

Purchase Orders Are Not Invoices

Purchase orders are commonly confused with invoices, which contain a lot of the same information. While they’re similar, there are some key differences between the two that you should be aware of. 

Difference #1: Who Issues It

In both cases, there are two parties involved: someone trying to buy something and someone trying to sell something. A purchase order is issued by the party trying to buy something. It outlines everything they want to buy and all the terms they expect the vendor to meet. 

An invoice, on the other hand, is issued by the seller to the purchaser to let them know that it’s time to make a payment. If the purchase is broken up into several payments, there could be several invoices associated with the same purchase order. 

Difference #2: When It’s Created

A purchase order is created as soon as there is intent to buy. An invoice is created once the sale is in progress or after it’s done. Basically, once the vendor has delivered on the purchase, it can issue an invoice, even if payment isn’t due for several months. 

Long story short: the purchase order always comes before the invoice. 

Difference #3: The Purpose It Serves

The goals of each of these documents are inherently different. The goal of the purchase order, for instance, is to specify the terms of a sale and put the wheels in motion to make that sale happen. A vendor can still come back with questions. They can even reject the purchase order and decide not to take it on. But by sending the P.O. to the vendor, the buyer is signaling that they’re ready to buy. 

The goal of an invoice is to collect payment on work that’s been done. The vendor uses an invoice to verify the details of the sale and kindly ask the purchaser to pay up. 

Purchase OrderInvoice
Issued by…PurchaserVendor
Issued when…Purchaser is Ready to Begin SaleVendor Has Completed Sale
Issued in order to…Start Purchase ProcessCollect Payment 

Steps to Issue a Purchase Order

Every company handles purchase orders a little differently, and every vendor has preferences for how they’d like to receive purchase orders. So the process for issuing one looks a little different depending on who you ask. That said, there are three basic steps every employee should follow before sending a purchase order to a vendor. 

  1. Document All Necessary Details: Put yourself in the shoes of your vendor and make sure that they have everything they need to complete your order. It’s a nice thing to do for them, but it also helps protect you later if anything goes wrong. In the case of our bookstore ordering copies of The Velveteen Rabbit, they probably don’t need much more on their purchase order than an item code and a quantity number. But when the publisher worked with the printer to make those copies, they had to specify every detail on their P.O. from how thick the paper should be to whether the cover should be glossy or matte. 
  2. Request a Quote: If you have an order form or order the same things often, you might already know the cost of your order and can simply send off a purchase order to your vendor. But if you’re not sure how much your order will cost, you’ll likely start off by requesting a quote. Just like purchase orders, your quote request should have all the necessary details clearly listed out so that the quote can be as accurate as possible. Then, you can use the quote to fill in the costs on your purchase order. 
  3. Follow Company Policies: Some companies set spending thresholds to avoid having too many purchase orders to keep track of. For example, your company may decide not to create P.O.’s for any purchases under $250. Whatever the threshold you decide, just keep it consistent. Many companies also have purchase order templates created so that all purchase orders are consistent, branded appropriately, and contain all the necessary information to avoid risk later on. 

If you’re new to purchase orders, start by working closely with your vendor to understand all the details that they need. You can then turn your initial purchase order into a template that can be tweaked and improved over time. 

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Components of a Purchase Order

The last step in the process is simply creating a purchase order. While your purchase orders may contain more or less information, here are the basic components you should include: 

  • Purchase Order Number: A unique identifying number provided by the purchaser that both parties can use to keep track of orders. 
  • Date: Always include the date when the purchase order was issued. 
  • Your Company Information: This should include the company name, a contact’s name, and a physical mailing address. If different, be sure to specify a shipping address as well. 
  • Your Vendor’s Information: Include your vendor’s company name and mailing address at a minimum. 
  • Item Names & Descriptions: Be sure to list the official item names on your P.O. along with any technical information the vendor might need to complete your order. In many cases, this includes item codes. Many vendors live by item codes, so check them twice for accuracy.  
  • Quantity: Clearly specify how much you want of each item on your P.O.
  • Item Cost: Break out the cost of each item on your purchase order by line and multiply by quantity. If you received a quote, consult your quote for exact costs. 
  • Total Purchase Amount: Add up your line item costs and consider tax. If you received a quote, this information should also be available to you there. 
  • Payment Terms & Information: Did you discuss 30-day payment terms on the phone? Make sure the terms of payment and all billing information is clearly outlined on the P.O. 
  • Signature Fields: In order for a purchase order to be a binding contract, both parties must sign it. Make sure your company representative has signed the purchase order before sending it to the vendor, and follow up to make sure that they’ve signed it, too. 

To summarize what should be included in a purchase order, simply make sure that your P.O. can answer all of these questions clearly: 

  1. Who’s buying? 
  2. Who’s selling? 
  3. What’s being purchased? 
  4. How will you be paying? 

As long as those four questions are answered fully, you should be in good shape to send off your purchase order. And remember, details are your friend. If you can’t afford for your order to be incorrect, use the purchase order to outline everything you can. 

Ready to learn more about best practices for managing your business? Find similar blog posts here.

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