What Is a Purchase Order and How Does It Work?
Learn how purchase orders streamline business transactions, ensuring clarity and control over your procurement process.
A purchase order (PO) is a formal business document used to initiate a purchase from a supplier. It outlines a buyer’s clear intent to acquire specific goods or services. For companies, POs are an important part of managing expenditures and streamlining the process of obtaining necessary supplies or services.
Defining a Purchase Order
A purchase order is a commercial document issued by a buyer to a seller, specifying the types, quantities, and agreed-upon prices for products or services. From the buyer’s perspective, it formalizes a request, providing a clear record of transaction details and helping to control spending. For the seller, it confirms an order, offering assurance of a committed sale before goods are shipped. This document becomes a legally binding contract once the seller accepts it, obligating the buyer to complete the purchase at the stated terms.
The primary purpose of a purchase order is to create a transparent record of a transaction, minimizing misunderstandings. It acts as a protective measure for both the buyer against incorrect deliveries or pricing, and for the seller against non-payment. This formalizes the agreement, moving beyond a verbal understanding to a documented commitment.
Components of a Purchase Order
A standard purchase order includes specific information to ensure clarity and accuracy for both the buyer and the seller. A unique purchase order number is assigned to each document for easy tracking and referencing within accounting and inventory systems. The PO also details the full contact information for both the buyer and the seller, including legal names, addresses, and sometimes email and phone numbers. This ensures proper communication and billing throughout the transaction.
The core of a purchase order involves a detailed description of the goods or services being procured. This typically includes item names, product numbers or SKUs, quantities, the agreed-upon unit price for each item, and the total price for each line item. Important logistical details such as the desired delivery date, the shipping address where the goods should be sent, and any specific shipping instructions are also provided. Finally, payment terms are clearly outlined, specifying when the invoice is due and any applicable taxes or fees.
The Purchase Order Process
The workflow of a purchase order begins with an identified need within a company, often leading to the creation of an internal document known as a purchase requisition. This requisition outlines the specific goods or services required and is submitted for internal approval, ensuring the purchase aligns with budget and operational objectives. Once approved, the purchasing department generates the formal purchase order, incorporating all necessary details identified in the requisition.
The completed purchase order is then issued to the selected vendor. Upon receiving and accepting the purchase order, the vendor confirms the agreement, at which point the PO becomes a legally binding contract. The vendor then proceeds to fulfill the order by preparing and delivering the requested goods or services according to the terms specified.
Following successful receipt and inspection, the vendor issues an invoice for the delivered goods or services. The buyer’s accounts payable department then performs a process known as three-way matching, comparing the invoice against the original purchase order and the goods receipt document. This matching process confirms that the items billed were indeed ordered and received, helping to prevent errors or fraud. Once the invoice is verified and approved, payment is processed to the vendor according to the agreed-upon terms, completing the purchase order cycle.