what is a purchase order?
A purchase order, or PO, is an official document released by a buyer with the obligation to pay the seller for the sale of specific services or products to be delivered in the future.
The advantage to the buyer is the ability to place an order without payment in advance.
From the seller’s perspective, a purchase order is a way to offer buyers credit without risk, since the buyer is committed to paying once the products or services have been delivered.
What are the Purposes of Purchase Orders?
Purchase orders are typically used when a buyer is willing to purchase inventory or supplies on account. This means the seller delivers or ships the purchased items prior to payment, with the purchase order ( PO ) serving as its risk protection.
There are also many reasons and benefits to using POs :
Along with legal protection, purchase orders serve as an important role in both payment tracking and inventory management.
They provide better accuracy, for both inventory and financial management. Specifically, purchase orders help suppliers or sellers to compare ordered inventory to the shipped inventory and on hand inventory which is useful for accuracy purposes.
They also allow suppliers or sellers to track when payments have been made on specific orders.
And buyers hold copies of orders they place to keep a continuous record of timely receipt of the items ordered.
POs also improve budgeting management, since funds need to be available before a PO is issued and enhance faster delivery, since POs help schedule delivery when the buyer needs it.
What is on a Purchase Order?
- Date purchase was made
- Name of the company buying the goods or services
- Description and quantity of the goods or services
- Price per item
- Payment information
- Billing address
- Purchase order number
- Shipping address
- Payment terms
- Expected delivery date
How is a Purchase Order Used?
A purchase order, PO, makes the purchase process simpler and easy to implement, which typically looks like this:
Buyer decides to purchase a service or product for their business and issues a PO to the seller, often electronically using a purchase order template.
The seller receives the PO and confirms if the company can fill the order or not.
If not, the seller informs the buyer that the order cannot be completed and the PO is canceled.
If the order can be filled, the seller starts preparing the order by pulling the inventory together or scheduling necessary personnel.
Then the order is shipped, or service is provided, and a PO number is assigned to the order or service, so the buyer knows which order has arrived.
After that, the seller invoices for the order, using the PO number so that it can easily be matched with the delivery information .The buyer pays the invoice according to the terms written in the PO.
What is the difference between purchase order and invoice?
A purchase order (PO) is the formal confirmation of an order. It is a document sent from a buyer to a seller that authorizes and initiates a purchase.
An invoice requests payment for a purchase. Invoices are sent from the seller to the buyer.
Accordingly, The key difference between a purchase order and an invoice is that a purchase order confirms that an order has been placed while an invoice requests payment for an order.
Why do companies use purchase orders?
Whether it is in a large organization with a full purchasing department or a small business, companies use purchase orders for several reasons:
1. To set clear expectations
POs enable buyers to make their needs clear to sellers. Both the buyer and the seller can use them as evidence in case orders are not delivered as expected.
2. To have more control over managing orders
POs give departments like procurement, finance, and operations formal and official documentation of incoming or pending deliveries, enabling them to track and manage orders more efficiently and effectively.
3. To help with budgeting
Once a PO is created, buyers can distribute the costs into company budgets and therefore, they spend more wisely.
4. To serve as a legally binding documentation
In the absence of a formal contract, a PO can serve as a legally binding document, but only after it is accepted by the seller.
5. To be a key part of audit trails
Auditors are on the lookout for financial discrepancies. recording, processing, and issuing. So, POs ensure that companies have what they need to provide auditing requirements to auditors.
Why do companies use invoices?
Companies use invoices for the following reasons:
1. They enable sellers to collect money
Most sellers don’t receive payment for a good or service until after an invoice is sent to the buyer. An email or phone call requesting payment won’t be enough.
2. They provide visibility into company spending
Invoices demonstrate exactly what you’re getting for your money, which gives finance departments more transparency.
3. They help companies manage payments
Invoices show what services or goods were sold, how much money has been paid to date, and any outstanding charges. And they help companies keep track of payments in a formal way.
What are the benefits that purchase orders and invoices have in common?
1. Invoices Like POs, they are legally binding. They show that particular service or good was provided and when payment is expected . Since , they prove that companies are charged for a service or good in case payment is not received.
2. Purchase orders and invoices are a key part of audit trails
Auditors need evidence of all money going in and out of businesses. As they show exactly what is charged for a service or good, they are a crucial part of audit trails.
Let’s take an example to make you familiar with the whole picture.
First, a department that needs to order materials makes a purchase requisition form. This form informs the purchasing department that supplies are required. The purchasing department can approve, deny, or alter the request.
If the purchase requisition is approved, the purchasing department will create a purchase order (PO). This PO is sent to the seller notifying them that the buyer wishes to purchase goods. If the seller accepts the order, it produces and delivers the goods with an invoice.
Then, The receiving department unpacks the goods and delivers a receiving report to the accounting department who already has the invoice and purchase order. When all of these documents agree, the accounting department can issue an invoice approval notice to the cashier indicating that a payment can be made to the seller.