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Purchase Order: Definition, Process and How to Create

By Team TranZact | Published on Dec 2, 2022

A Purchase Order (PO) is an essential business document used for budgeting, expense tracking, and supplier management. As a buyer, you will create purchase orders to prevent miscommunications with suppliers and cut down on unexpected costs. This article will focus on purchase order creation, purchase order systems, types of purchase orders, and more.

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What Is a Purchase Order?

A purchase order is a commercial source document that a business' purchasing department issues while placing an order with the suppliers or vendors. It includes all details regarding the items to be purchased, like the types of goods, price, and quantity.

Generally, a purchase order is an agreement drafted by a buyer while purchasing items from a seller. Purchase orders are helpful for both sellers, and buyers since it specifies the goods needed, and the delivery time. This helps to streamline vendor management, financial record keeping and increases business efficiency.

How Does a Purchase Order Work?

Purchase orders can act as legally enforceable contracts. To understand the working process of a purchase order, we will need to know how to create a purchase order.

1. Buyer orders items from the seller:

Before placing an order, the buyer must identify the product need that the seller's company can fulfill. In this step, the buyer has to identify the necessary products, the quantity needed, and the time margin of fulfilling the need.

For example, if you need to order packaging boxes for your product shipping, you must calculate the number of packages you need, and when you will need them. If you’re expecting increased demand this year due to the upcoming holidays, you should multiply last year's box order by your business' estimated growth for this season, to determine the right order amount.

2. Buyer drafts PO, and sends it to the seller for approval:

After determining the above information, the buyer has to raise a purchase order, and ask the seller to approve it. While sending the PO, remember to mention when you need the approval so that the process runs on time.

The approval response, whether yes or no, should come in early enough, to leave the buyer with ample time to source from different sellers if necessary, without delaying production schedules.

3. Seller reviews the PO, and confirms/rejects to fulfill the request:

After receiving the PO, the seller will decide when to review the request and check the product availability or inventory, to confirm if the order can be fulfilled within the timeline.

After a careful review of inventory, and shipping capacity the seller will confirm if he can proceed with the request or if he might have to reject it for some reasons, like inadequate inventory.

4. Your PO is approved:

The seller will approve the purchase order if he can fulfill it as instructed, and this approval will legally bind both parties.

In the example of packaging boxes as mentioned earlier, if the box company approves your request, it will send an approved purchase order to you for your confirmation.

5. Product fulfillment:

After the purchase order approval, the seller will deliver the product within the agreed time frame. At this stage, the seller can also create, and send an invoice to the buyer to indicate the cost of the PO. This invoice will display the provided goods details, owed amount, and relevant quantity.

For example, after the shipment of boxes is approved, you will receive a fulfilled order with an invoice for the owed amount along with payment terms mentioned.

6. The invoice is paid:

At this stage, the buyer will check the quality of goods received and record the same with an Inward and Goods Received Note document. The buyer then has to pay the invoice amount as per the seller's payment conditions.

Purchase Order Format

Having a written agreement regarding the prices, and quantity of items in your purchase order protects both you, and your seller. For a purchase order, you need to include the following information.

1. Header: Provide your company details such as name, business address, purchase order number, and purchase order date.

2. Vendor information: Indicate the recipient of the purchase order. You will have to list the name of the seller, the specific contact name, and the address of the seller's company.

3. Shipping address: Specify the location area, where the order will be delivered to, the shipping method, shipping terms, and the intended delivery date.

4. Order details: Provide a line item with the Stock Keeping Unit (SKU) number or product code, item description, name, price per unit, quantity of requested units, and the delivery date of each product.

5. Summarize: Complete the PO by providing the subtotal PO amount, applicable discount, shipping costs, taxes, and total PO invoice amount.

Purchase Order Template

With purchase orders, you get a legally binding record of exactly what you ordered, and at what price. In a purchase order form, the following fields will be included:

  1. Company name, address, city/ state, zip code, date of order, and order number.

  2. Vendor contact name, client company name, address, and phone.

  3. Shipping details including user's name, department, client company name, address, and phone.

  4. Other shipping information including, shipping method, shipping terms, and delivery date.

  5. Product information including code, product name/ description, quantity, unit price, and delivery date.

  6. Payment information including the total amount, discount, subtotal less discount, tax rate, total tax, shipping/ handling charges, and the total amount.

Types Of Purchase Orders

Even though all purchase orders have a similar base pattern, depending on how much information is included, generally five types of purchase orders are available:

1. Standard Purchase Orders

These purchase orders are widely used and are the most common type. The buyer is certain about the purchase details and can identify the kind of items to buy, the delivery schedule, quantity, and payment terms.

For example, a business running low on printer cartridges can place this as a standard order as they know the amount they need, and when they should have it. Standard POs can be generated for different functions depending on the requirements, such as subcontracting, services to be rendered, consignment, etc.

2. Planned Purchase Orders

A planned purchase order is made depending on the buyer's estimation of the company's future needs for the product by submitting an advance purchase order. In this case, even though the item details, price, and payment terms are known, the quantity is determined by an educated guess.

For example, suppose a company with a low amount of printer cartridges asks for a planned purchase order. In that case, the person in charge will determine the number of printer cartridges needed with a flexible delivery schedule.

3. Blanket Purchase Orders

In this order, the buyer can place multiple orders simultaneously to ensure discounted pricing. For example, suppose the company mentioned above negotiates a better deal by agreeing upon bulk orders of printer cartridges with paper from them. In that case, it will be eligible to use a blanket purchase order to buy those products.

4. Contract Purchase Orders

In a contract purchase order, the seller, and buyer will sign a contract, which will outline the terms of buying, before a purchase order is issued referencing the contract. These POs provide legal protection for both parties.

For the printer supplies, if the company signs this contract displaying the items, pricing, quantity, and delivery schedule followed by a standard purchase order, the company will fall under the purchase order agreement.

5. Digital Purchase Orders

A set process for purchase orders can help in easy procurement, and benefit both sellers, and buyers. You can easily create a digital PO using an automated purchase order tool.

A purchase order tool, provides pre-existing templates with all required fields. All you need to do is, enter the required information and the software will create a PO for you in one click. An expert PO software may enable you to add new custom fields to the purchase order.

Purchase Order System

A purchase order system is an organized software module that generates purchase orders, manages them, and tracks digital purchase orders in a secure and automated way.

A purchase order system is interconnected with other modules like purchase transactions module, and inventory to update the respective departments and proceed with the order usage.

To create a purchase order, one must abide by the following guidelines:

1. Determine the right form of PO:

Based on the types of purchase orders available, determine the best PO type for your business requirements.

2. Design a workflow:

To automate the purchase order system within your business, outline the necessary steps your department needs to execute the purchase order from beginning to end.

You can make a purchase order workflow to showcase step-by-step interactions regarding storing or transferring of data.

3. Dictate assigned roles, and accessibility:

Your team members should be aware of how to accurately assign job roles to ensure that the PO workflow is directed towards completion. The team will be required to set access permissions efficiently to external stakeholders, for them to contribute to the orders.

4. Start, and refine the purchase order:

If you use, and follow the purchase order system, you'll need to collect feedback from your internal team, and stakeholders continuously. Determine the steps to be improved, and refine purchase orders with the changes in the workflow. Eventually, you will have a productive system and a seamless manufacturing chain.

Purchase Order Example

A Purchase Order includes the customer's data, the shipping terms, the desired products, and the purchase order number. It can also have a note addressing the vendor. Some vendors will want to fill in business information; therefore, on the vendor section of the header, leave the section blank so they can fill it out.

Benefits of Purchase Orders

Purchase orders are important to avoid any future disputes between clients and vendors. There are various benefits of issuing a purchase order. The most important ones are:

  1. It ensures improvement in accurate inventory and purchase management, along with financial management.

  2. Purchase orders ensure better budgeting as the business needs to have required funds, before the purchase order is issued.

  3. It ensures faster delivery as purchase orders require scheduled delivery as per the buyer requirements.

  4. It also helps to avoid duplicate orders in case of large scale orders. Purchase orders can help to track orders effectively and find out what goods have been ordered by whom.

Purchase Order vs Invoice

Purchase orders are documents containing order details such as the product name, amount, the date it should be delivered, and more, generated by a buyer, and helps to order goods from the supplier.

On the other hand, an invoice is generated by the supplier and displays the payable amount by the buyer for the product sent by the supplier. The difference between a purchase order and invoice is that the former is an agreement of sale, while the latter confirms the sale and payment terms.

Work Order vs Purchase Order

The major difference between a work order, and a purchase order is that work orders typically deal with internal tasks, and labor instructions. Purchase orders are used to raise an external purchase request for goods, raw materials and equipment required for one’s production.

Once a PO is confirmed, the supplier will procure the goods mentioned in the PO for the buyer. And if the supplier/ seller does not have them ready, he will raise a work order for his production teams to get the required order ready for the buyer.

A work order is created based on the quantity and other requirements mentioned in the PO, but does not include the price details usually.

Supply Order vs Purchase Order

A purchase order is created by the buyer or customers specifying the details of goods to be purchased. It creates a legally binding contract between the buyer and seller.

Whereas a supply order is a document given to the buyer that can be used to obtain the item from the dealer. A supply order contains all details about the order of goods given to the vendor.

Sales Order vs Purchase Order

The major difference between a sales order and purchase order is that the purchase order is raised by a buyer in need of goods and sent to the supplier.

A sales order on the other hand, is raised by the supplier or seller once the PO is approved and initiated for production or delivery. It stands for approval or confirmation of the upcoming sale.

Nowadays, the purchase order process is not necessarily paper-based, and the buyer can send an electronic or digitized PO to the supplier. This can be done with the help of the PO module available in a business automation software. It ensures a quick purchasing procedure while decreasing the chances of any error.

Purchase Order vs Quotation

A purchase order is a formal request sent by a buyer to the supplier. It will contain the item details, the time limit within which the order needs to be sent, and the like.

However, a quotation is sent or received when a buyer or supplier first contacts different vendors to confirm one, for their upcoming requirements.

When a buyer is in need of certain goods, he sends a Request for Quotation (RFQ) to various sellers. The RFQ includes the list of desired products, and other details. The supplier then receives this quotation and shares a one-time estimate provided to the customer with no bearing on inventory.

Purchase Order vs Purchase Requisition

Purchase requisition is used to request purchases by the employee. It is sent internally from one employee to the senior, or to the department manager for approval. However, a purchase order is the confirmed order requirement, approved by the departmental authority, and it is sent externally by the company employee to a vendor.

The purchase department can create a purchase order only when the purchase requisition is approved. The main difference between a purchase order and purchase requisition is that a purchase order is an external document.

Manage Purchase Orders Expertly With TranZact!

A purchase order is the foundation of the procurement operations in your business. Automate your purchase order system with TranZact to streamline your purchase order processes and follow-ups.

With TranZact, you can manage all your purchase orders on a single dashboard with minimal manual dependency. It enables effective record keeping, easy status updates, eliminates miscommunication and missed orders, ensuring timely delivery of supplies!

TranZact also equips you to add new custom fields to the purchase order document, based on your requirements. This allows you to customize the purchase order and add more important details to the existing template.

In addition to a PO, you can also create several other important documents with TranZact such as sales order, goods received note, quotations, challan, invoices and more! It also helps you with other core modules like sales, inventory, production and business intelligence, thereby empowering your manufacturing business to grow exponentially!

FAQs on Purchase Order

1. When should a purchase order be used?

A purchase order should be used if the buyer wants to place an order for supplies. Once approved by the seller, a PO is used to update inventory, create work orders and proceed with production to fulfill sales orders.

2. Who should issue a purchase order?

The buyer who wants to ensure they receive exactly what they need as supplies, with legal support in case of discrepancies, should issue a purchase order.

3. What is the purpose of a PO?

Purchase Orders are essential documents for buyers as they formalize goods requirements, pricing, and are legally binding documentation of ordered goods for manufacturing companies.

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TranZact is a team of IIT & IIM graduates who have developed a GST compliant, cloud-based, inventory management software for SME manufacturers. It digitizes your entire business operations, right from customer inquiry to dispatch. This also streamlines your Inventory, Purchase, Sales & Quotation management processes in a hassle-free user-friendly manner. The software is free to signup and gets implemented within a week.