What Are Purchase Orders and How Do They Work?

A purchase order (PO) is a formal document issued by a buyer to a seller, outlining the specific goods or services a buyer intends to acquire. It represents an official offer to purchase, detailing the types, quantities, and agreed-upon prices for products or services needed. This document helps control the acquisition of items and services from external suppliers, providing a clear record of the buyer’s intentions in a business transaction.

Key Elements of a Purchase Order

A comprehensive purchase order includes specific details to ensure clarity and prevent misunderstandings. Each PO is assigned a unique PO number for tracking and referencing. The document states the names and contact information for both the buyer and the vendor, including addresses.

For each item or service, the purchase order specifies a detailed description, quantities, and the agreed-upon unit price. It also calculates the total price for each line item and the grand total for the entire order. The PO outlines logistical information such as the requested delivery date, shipping address, and delivery terms. Payment terms, such as “net 30” or other agreed-upon schedules, are stated.

The Purchase Order Process

A purchase order begins when a buyer identifies a need for goods or services and creates the document. This often follows an internal purchase requisition. Once generated, the purchase order is sent to the selected vendor.

Upon receiving the purchase order, the vendor reviews and accepts the terms, at which point the PO becomes a legally binding agreement. The vendor then fulfills the order. Once goods or services are delivered, the buyer performs a “three-way match,” comparing the purchase order, the delivery receipt, and the vendor’s invoice to verify accuracy before payment is released.

The Role of Purchase Orders in Business Transactions

Purchase orders formalize business commitments and streamline procurement activities. They act as a legal agreement between the buyer and the seller once accepted, providing clear evidence of the agreed-upon terms and conditions. This helps protect both parties by documenting specifics like quantities, pricing, and delivery schedules, which can be referenced in case of disputes.

Purchase orders provide a transparent record of all purchases, assisting in tracking expenditures and managing inventory levels. They facilitate accurate budgeting and financial forecasting by providing an organized trail of spending. By outlining expectations upfront, purchase orders help prevent misunderstandings between buyers and sellers.

Purchase Orders Versus Invoices

While both purchase orders and invoices are integral to business transactions, they serve distinct purposes and are generated at different stages of the procurement cycle. A purchase order is initiated by the buyer at the beginning of a transaction. It acts as an offer from the buyer to the seller, detailing the goods or services the buyer wishes to acquire.

In contrast, an invoice is issued by the seller after the goods or services have been provided. It requests payment from the buyer for the delivered items or completed services. The purchase order outlines the intent to purchase, while the invoice is a bill for what has been supplied. The invoice often references the original purchase order number, allowing the buyer to match it against the pre-approved purchase.