As a business owner managing relationships with suppliers, it's important to know what a purchase order is and how it works.
Imagine you run a small business and need to buy inventory or services from a vendor. You want to ensure a smooth transaction, detailing exactly what you're buying, at what price, and when you need it. To explain this information efficiently to your vendor, you'll use a purchase order detailing the transaction.
The purchase order formally confirms the buyer's intent to purchase goods or services under specified terms and conditions. By providing clarity and documentation of the agreement, purchase orders help prevent misunderstandings and disputes between parties.
Now that you understand the basics of purchase orders, you should learn more about them and how the purchase order process works to ensure a smooth relationship with your suppliers.
A purchase order (PO) is a buyer's official request to a seller to supply goods or services at a specified price before a certain deadline. It's a formal document that outlines the transaction details agreed upon by both parties.
Purchase order vs. invoice
Purchase orders and invoices are used in the procurement process but are not the same document.
The buyer issues a purchase order to a seller as a formal request for goods or services. If you have a purchasing department, they'll send the purchase orders. If not, managers and others with the authorization to purchase products or services from suppliers can do so.
The purchase order is a precursor to the actual transaction, outlining the details of what the buyer intends to purchase and under what conditions. The vendor views the purchase order when fulfilling orders.
On the other hand, the seller generates an invoice and issues it to the buyer after the goods have been delivered or the services rendered. It's a request for payment for the products or services provided.
A purchase order is also different from a purchase requisition. Employees use a purchase requisition internally to ask their employer to purchase products or services for internal purposes.
The basics of purchase orders for services
Purchase orders can be issued for products or services, and the process is fairly similar.
Purchase orders for services typically include:
- Service description: This clearly describes the services to be provided, including any specific requirements or deliverables.
- Service provider information: This section provides details of the service provider, such as name, address, and contact information. You should also include the purchase order date to ensure proper communication with your vendor.
- Service dates: These are delivery dates for the commencement and completion of the services.
- Service fee: This is the agreed-upon fee for the services, including any applicable taxes or additional charges.
- Terms and conditions: This section outlines any terms and conditions governing the provision of services, such as payment terms, confidentiality agreements, or service level agreements.
Purchase orders for services help ensure clarity and accountability in service transactions, outlining expectations for both parties involved.
Creating a purchase order involves several key steps that facilitate the procurement of goods or services in a structured and organized manner. Remember, the buyer creates the purchase order.
Companies may have purchase order templates their clients and customers can use to make the process easier. Still, it's your responsibility to ensure the information is correct when creating a purchase order.
Here's how the purchase order process works:
1. Request for services
The purchase order process typically begins with a request from the buyer for specific goods or services. This request outlines the requirements and expectations, including the type of services needed, quantities, desired delivery dates, and any special instructions or preferences.
2. Supplier evaluates the request
Upon receiving the service request, the supplier evaluates the scope and feasibility of fulfilling the buyer's requirements. This evaluation involves assessing resource availability, capability to deliver the services within the specified timeframe or by a certain date, and alignment with the supplier's expertise and offerings.
3. Supplier provides a service proposal
Based on their evaluation, the supplier prepares and submits a service proposal to the buyer.
The proposal outlines the proposed approach to delivering the services, including a description of the services to be provided, estimated costs, timelines, and terms and conditions. This proposal serves as the basis for further negotiation and finalization of the purchase order.
4. Customer approves the proposal and issues a PO
After reviewing the service proposal submitted by the supplier, the customer evaluates whether it meets their requirements and aligns with their budget and timeline. Upon approval, the customer formally issues a purchase order (PO) to the supplier.
You can issue electronic purchase orders or create a purchase order template and print it before mailing it off to your supplier. Of course, you should always check with your supplier to ensure you're sending the purchase order correctly. Many may prefer digital purchase orders to make the process more convenient for both parties.
Remember that a PO is not a legally binding contract until the supplier agrees to fulfill the request. Once the seller agrees, the purchase order becomes legally binding.
5. Supplier delivers the service
With the PO in hand, the supplier begins delivering the agreed-upon services according to the specifications outlined in the PO. This may involve assigning resources, scheduling tasks, and coordinating with the customer to ensure a smooth and timely delivery of the services.
6. Customer verifies the service completion
Once the services have been delivered, the customer verifies that the work has been completed according to the terms and conditions specified in the PO and the service proposal.
This may include reviewing deliverables, conducting quality checks, and confirming that all requirements have been met to their satisfaction.
7. Supplier sends an invoice based on the PO
After the customer has verified the completion of the services, the supplier prepares and sends an invoice to the customer for payment.
The invoice details the services provided and the corresponding costs per the terms outlined in the PO. Upon receipt of the invoice, the customer processes payment to the supplier, completing the transaction and fulfilling their financial obligation.
Types of purchase orders
Depending on your needs and relationship with the supplier, you might create a specific purchase order. Purchase orders can vary, but there are four main types you should know about. These include:
Standard
Standard purchase orders are the most common type for one-time goods or service purchases. They specify the details of a single transaction, including item descriptions, quantities, prices, delivery dates, and terms of sale.
Standard POs are typically used for routine procurement needs and are issued as needed to fulfill immediate requirements.
Planned
Planned purchase orders are created in advance to forecast and plan for future procurement needs.
Unlike standard POs, which are issued for specific transactions, planned POs signal the intent to purchase goods or services over a specified period. By providing visibility into anticipated purchasing activities, they help organizations streamline inventory management, production scheduling, and budgeting.
Blanket
Blanket purchase orders are used to establish long-term agreements with suppliers for recurring purchases of goods or services.
Instead of issuing individual POs for each transaction, a blanket purchase order outlines the terms and conditions of the overall agreement, including pricing, delivery schedules, and quantity commitments.
Blanket POs offer flexibility and efficiency by consolidating multiple transactions under a single contract, simplifying procurement processes, and reducing administrative overhead.
Contract
Contract purchase orders formalize agreements between buyers and suppliers for ongoing procurement needs. They are often used for strategic partnerships or large-volume purchases where a comprehensive contract is necessary to govern the relationship.
Contract POs specify pricing, payment terms, delivery dates, and more. By establishing clear expectations and obligations upfront, contract POs help mitigate risks and ensure compliance with contractual agreements.
While purchase orders are essential documents in procurement for products and services, there are distinct differences in how they are structured and what they entail.:
Scope of work
Purchase orders for products typically include detailed descriptions of the items being purchased, such as part numbers, quantities, sizes, colors, and specifications.
Conversely, purchase orders for services outline the scope of work to be performed, including the nature of the services, tasks to be completed, milestones, and any specific deliverables or outcomes.
Deliverables and timing
Purchase orders for products specify a delivery date, shipping instructions, and any special handling requirements for the physical delivery of goods.
On the other hand, purchase orders for services define the timing of service delivery, including start and end dates, duration, and any milestones or deadlines for the completion of specific tasks or project phases.
Pricing structure
Product purchase orders typically include unit prices, total costs, and applicable taxes, discounts, or shipping charges.
In contrast, purchase orders for services may have more complex pricing structures, such as hourly rates, fixed fees, milestone payments, or retainer agreements, depending on the nature of the services and the agreement between the parties.
Legal and compliance requirements
Purchase orders for products may be subject to industry-specific regulations, product standards, warranties, and return policies, typically addressed in the terms and conditions of the purchase order.
Conversely, purchase orders for services may involve additional legal considerations, confidentiality agreements, and service level agreements (SLAs) to protect the interests of both parties.
Creating your purchase order system
Creating a purchase order system streamlines procurement processes and maintains efficient supplier relationships. Whether issuing standard purchase orders for one-time transactions or setting up blanket purchase orders for recurring purchases, having a well-defined system ensures transparency, accountability, and compliance with contractual agreements.