Purchase order definition: What is a PO, and how does it work?

A purchase order, commonly abbreviated to PO, is a legally binding document that confirms a business’s intent to buy goods or services from a supplier.

It details the full list of items being purchased including quantities, payment terms and agreed delivery dates.

There are multiple reasons to issue a PO. For one, it helps you get on top of cashflow management as you know how much money will be leaving your account in a given period, so you can plan and budget accordingly.

It’s important to understand the PO meaning, since many businesses use them to create a paper trail for their bookkeeping records.

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Purchase order definition

What is a purchase order, and how does it work?

A PO, or purchase order, is a legal document issued from a buyer to a vendor or supplier, to confirm that payment will be made for goods at a later date.

A purchase order should contain the amount of money due to be paid to the seller. It should also show the method of payment and a concrete date for the agreed-upon payment.

A purchase order can be useful for creating good long-term relationships with suppliers, as having a clear expectation for the order minimizes the risk of dispute on both ends.

For example, if you run an organic fashion company and have to source your textiles from a factory in India, you can issue a purchase order to the overseas supplier. The supplier will see exactly which textiles you require, and accept if they have the necessary inventory to fulfill it.

You can also set up recurring purchases with a standing purchase order. This is useful if you need to order a set amount of the same textiles every six months. A recurring purchase order uses the same PO number, so the supplier can easily identify your PO each time.

What is the purpose of a purchase order?

The formal purchase order document can help business owners with bookkeeping efforts, but it’s an often misunderstood concept.

So what purpose does a purchase order serve?

A purchase order is considered a legal contract between the buyer and seller. It is important to note that a PO is only legally binding once it has been approved by the vendor or supplier. This is to protect against cases where the supplier may not have the goods requested.

By issuing a PO, you’re agreeing to pay for the goods described at a future date once confirmed by the supplier. This helps your business foresee what accounts payables to prepare for. It also helps you better manage inventory if your business is goods-based.

If your business has a dedicated purchasing or procurement team, then purchase orders can form part of a robust purchase approval process.

If there is a need for goods or supplies within the company, a request is sent to the procurement team, the team can approve or reject the order based on budget and supporting documents. If the order is approved, the PO is prepared and sent to the supplier.

Once the goods are received and the invoice comes in, the PO can also be used to check that the invoice matches the agreed order. This way, when you balance your books you can check that they’re 100% accurate.

How to use a purchase order

To make a purchase order, you’ll have to go through the following steps:

• Pick out the item/s you want to purchase;
• Complete the purchase order by describing each item in detail;
• Include a PO number, and specify the quantity and a sum of money payable for each item and the total of all the items at the bottom;
• Send the purchase order directly to your seller or via a sales representative;
• Wait for the seller to confirm the payment order.

What information should you include on a PO?

There are several important pieces of information to include on a PO, which are as follows:

• Your company name and the customer’s name
• Address and phone number for both you and your customer
• Desired shipping address
• Date issued
• Purchase order number
• Payment method
• List of purchased items with the quantity of each and their prices
• Total price including tax, any discounts, and shipping if applicable
• Order delivery date
• Payment terms

Pros and cons of using purchase orders

Purchase orders can help business owners, but they can also be a burden.

Pros:

• They provide key information for sellers, such as where to send the invoice and ship the goods.
• It creates a legal contract between buyer and seller which creates security.
• It streamlines receipts, payment tracking, and bookkeeping processes.
• They provide you with a convenient paper trail for future budgeting.

Cons:

• POs create more paperwork due to the additional approvals

What types of problems does a purchase order prevent?

Purchase orders can help you overcome and avoid various issues in the day-to-day operations of your business.

Here are some of the main issues you can prevent by creating and using purchase orders:

• Purchase orders can help to avoid order errors;
• They prevent misunderstandings in pricing between the buyer and seller;
• For international orders, using POs can reduce the risk of shipping delays by setting clear expectations.

What is a purchase order vs invoice?

An invoice is as important to a business as a purchase order, if not more.

• The invoice provides an itemized list of goods or services supplied and serves as an official request for payment.
• The purchase order provides an itemized list of goods or services due to be purchased.

So while the seller issues invoices to buyers, buyers can issue purchase orders stating intent to buy a certain quantity of goods. In terms of a timescale, the purchase order is only ever issued before an order is fulfilled. The invoice is typically issued afterward upon completion of the sale.

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