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What Is a Purchase Order? Everything You Need To Know

MHC Marketing    March 31st, 2022

What Is a Purchase Order Illustration

Business owners and department heads are often consumed by the never-ending tasks of tracking inventory, ordering supplies, and monitoring their spending. These are all things that take focus and energy away from the more innovative work that would help their company become more successful.

The use of purchase orders (POs) helps decrease the chaos surrounding financial and operational tasks. POs simplify the purchase process, allow you to make better budgeting decisions, and protect your company in the rare case of supplier disputes. 

This piece will explain what purchase orders are, how to create them, review the purchase order process, and reveal the many benefits you stand to gain from using them.

What is a Purchase Order?

A purchase order (PO) is a legally binding document a buyer uses to authorize a purchase from a supplier. POs contain a list of goods or services purchased and their prices and payment terms. POs are important for both buyers and sellers. They clearly state already agreed-upon business arrangements, ensuring that sellers can supply goods or services as promised, and businesses can maintain accurate records of expenditures for financial purposes.

In worst-case scenarios, such as a lawsuit over lack of payment or discrepancies between a buyer and seller, POs serve as useful and admissible evidence detailing the terms of a transaction.

What Information Does a PO Contain? 

Purchase order templates can differ from company to company, but, in general, they contain:

  • A list of the products or services purchased
  • The quantity of each of the products or services purchased
  • The model or SKU numbers and specific brand names of each of the products or services
  • The price per unit of products or services
  • The company’s billing address
  • The anticipated delivery date of the products or services
  • The anticipated delivery location of the products or services
  • The agreed-upon payment terms with the supplier

The Difference Between a Purchase Order and an Invoice

Though they contain similar information, purchase orders and invoices are different documents created by different parties. Purchase orders are created by buyers. They are approved internally and then sent to the seller to initiate the order and verify the terms of their purchase agreement.

Upon receipt, vendors accept the PO and generate an invoice to send back to the buyer along with the completed order. Invoices typically contain the PO number, an invoice number, and an itemized cost breakdown of goods or services rendered.

Simply, the invoice is for the seller’s records, while the PO is for the buyer’s records.

How to Create a Purchase Order? 

Purchase orders don’t have to be fancy; you can produce them manually in programs like Google Sheets or Microsoft Word. There are also plenty of downloadable, personalizable templates online. A better alternative, however, is workflow automation software, which automatically generates POs for your finance team and can even extract information from paper POs一a huge time-saver during month-end close.

MHC’s order processing solution automatically interfaces with your ERP system to collect data and convert it into legible, business-facing documents, like purchase orders. The software then distributes the output electronically, as needed.

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Types of Purchase Orders

While the content of most purchase orders is similar, there are several types of purchase orders that serve specific purposes. Below are a some of the most common forms of POs:

STANDARD PURCHASE ORDERS
Standard purchase orders are the most popular type of POs. They are used when the buyer is clear on what they want to purchase. To use a standard PO, you should know what product or service you’re buying, how much of it you’re purchasing, when it should be delivered, and how and when you will pay. Since you need to know these details in advance, finance teams use standard purchase orders for recurring office supplies or inventory purchases.

PLANNED PURCHASE ORDERS

These aren’t as specific as standard POs because buyers aren’t sure about their company’s future needs. These purchase orders have concrete details about the product or service the company wants to buy, but list a rough estimate of the quantity and a more flexible delivery date.

BLANKET PURCHASE ORDERS

Sometimes, buyers place many orders at once to hit a bulk order discount. These POs look like standard POs but have larger quantities than usual and list the negotiated discount at the bottom of the purchase order.

DIGITAL PURCHASE ORDERS

Digital purchase orders are what they sound like一a PO sent electronically. Many modern companies opt for this approach because tracking these POs in their ERP and other workflow automation systems is much easier.

CONTACT PURCHASE ORDERS

They are much more formal in that both the buyer and seller sign a contract that details the terms of a purchase before the official PO is issued. This type of PO provides the most legal coverage for both parties and notes the signed document on the purchase order for future reference.

How Does a Purchase Order Work?

A good purchase order is a crucial part of your AP department, and your business as a whole, but it’s important that the process it follows is just as solid.

Since a purchase order is a binding document, companies usually have a strict purchase order process to ensure that POs are created, approved, and tracked appropriately. This varies from company to company, but for the most part, businesses follow the same order of operations. The first piece of the process is determining who can send and approve POs.

Purchase order issuer and approver illustration

Who Issues a Purchase Order?

At the highest level, buyers are responsible for issuing a PO to the seller. At your company, POs can be generated by your accounting department, someone on a team requesting the goods or services, or anyone else authorized to create POs.

Who Approves a Purchase Order?

The seller, or company providing the goods and services, approves purchase orders once they are received. Again, the person or persons processing the approval could vary. Some companies have a multi-step process with several approvers depending on the dollar amount of the PO. No matter who is responsible for approvals, they need to be made aware of the implications of accepting a purchase order, and that they are committing to delivering a set of goods or services by a specified date.

The Purchase Order Process

Once issuers and approvers are identified, it’s time to start the purchase order process. Below, we walk through each step in detail:

1. PO CREATION

As soon as a buyer has selected the goods or services it intends to buy, the designated issuer within the company should create a PO that specifies which items they are purchasing, for what price, and under what terms. It’s important to be thorough, as purchase orders facilitate reconciliation for the accounts payable team down the line. After the PO is approved internally, it’s sent to the seller.

PO Creation illustration
Receive the Goods Receipt illustration

2. RECEIVE THE GOODS RECEIPT

The goods receipt (sometimes called a “packing slip”) outlines what is contained in an order. A seller sends this along with the order so the buyer can inspect the order and ensure all the goods on the receipt are present in the package.

3. RECEIPT OF VENDOR INVOICE

When a seller receives a PO, it’s an indication that they should send an invoice with the corresponding PO number. Invoices usually come with the goods receipt and show the cost breakdown of each item in the order. The invoice should line up exactly with what was stated on the purchase order.

Receipt of Vendor Invoice illustration
Three Way Matching Illustration

4. THREE-WAY MATCHING

When a buyer receives the order, they use a process called three-way matching to ensure that the order is correct. The three-way match is between the purchase order, goods receipt, and invoice. The quantity, type, price, and delivery of goods should match up on each document.

5. FINAL APPROVAL AND PAYMENT 

When the buyer completes their three-way match, the invoice is routed to the appointed approver. Once approved, payment is released, and the PO is marked as paid or closed.

Final Approval and Payment Illustration

The Benefits of Using a PO

The primary benefit of a PO is to record proof of purchase. But of course, there are many more. POs enable buyers to structure and negotiate their payments in a way where they can purchase goods now and pay later, receive discounts, and more.

On the flip side, purchase orders help sellers track their inventory, plan for recurring orders, and guarantee that their operations are running smoothly. What’s more, POs provide a measure of security for both parties. Buyers know they’ll receive their goods or services on time, and sellers know how much they are getting paid and when.

The Benefits of Automating the PO Process

While POs are extremely beneficial, the purchase order process can be tedious, particularly if you handle it manually. It’s time-consuming and prone to costly mistakes. 

In fact, 85 percent of employees report losing at least one to two hours of productivity a week searching for information. According to the Bureau of Labor Statistics, this equates to $60 in lost wages per week per employee. 

Fortunately, there are tools to streamline the PO process. Workflow automation boosts productivity and has other cost-effective benefits for your business, such as:

CENTRALIZED POs

Instead of trying to collate pieces of physical paper or multiple electronic documents, workflow software automatically stores your POs in a centralized, searchable way. Since all POs are housed under one virtual roof in the cloud, accounting teams can review past and present POs, no matter if they’re in the office or working remotely. This is an especially important benefit now that remote work has become the norm for more people, due to the pandemic.  

FASTER PO APPROVAL PROCESS

Manual approval workflows are ripe for inefficiency and bottlenecks. Automation immediately notifies the appropriate parties of approvals that need to be made to keep things moving along quickly. 

TRANSPARENCY INTO BUDGET AND SPENDING

Purchase orders inform finance teams of big purchases coming down the line so that they can plan accordingly. Workflow automation software can surface other POs in the queue to approvers so that they can estimate cash flow in real-time and avoid approving POs mistakenly.

DECREASES ADMINISTRATIVE ERRORS

Accurate record-keeping is critical for businesses, but POs can fall through the cracks with disorganized manual PO processes. It’s hard to pinpoint duplicates, perform three-way matching, and reconcile at the end of the month. Poor bookkeeping can set your company back in terms of time and money. Automation software ensures that the right records are being monitored and accounted for with required fields, reminders, and customized workflows.

Streamline Your Purchase Order Process 

With so much to keep tabs on, the last thing you want to do is make it harder on yourself. Purchase orders can help you get what you need on time, prevent payment confusion, and streamline your overall accounting process. But forming a solid PO process only gets you so far. Workflow automation brings even more efficiency and clarity to both PO and accounts payable processes.

MHC NorthStar is cloud-based software specializing in intelligent workflow automation for the Accounts Payable process and beyond. With features like three-way matching, MHC allows for efficienct, end-to-end automation that saves money and time, all while helping maintain positive relationships with vendors and suppliers. 

MHC’s workflow automation reports provide AP power users with visibility into invoices throughout the entire approval cycle, allowing them to find and eliminate inefficiencies. By converting information from paper or emailed invoices into clean data, your AP team will be able to increase on-time payments and decrease your cost-per-invoice rate. 

Additionally, our solution for order processing documents can interface with your ERP to automatically perform tasks, including generating purchase orders and AP checks based on the required banking format. This allows your company to leverage the benefits of automating your payment process, like receiving early payment discounts. 

Overall, MHC users benefit from decreased approval bottlenecks, increased spending transparency, and better internal and external communications. Learn more about MHC NorthStar by requesting a personalized demo today.

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