How to Create and Use Purchase Orders: A Small Business Guide
by Robert Izquierdo | Published on May 18, 2022
Purchase orders are part of every company. Whether you’re receiving them from customers, sending them out to your suppliers, or even using them internally between departments of the same company, purchase orders are a regular occurrence when running a business.
If you’re establishing your company, you’ll have to address purchase orders sooner or later. It may seem like an administrative headache, but every business must capture its sales in some type of purchase order. Here, you’ll learn the details of implementing a purchase order system at your organization.
Overview: What is a purchase order?
A purchase order (PO) is a customer’s official confirmation of an order to buy a company’s products or services. It’s a document sent from a buyer to a vendor authorizing a purchase, and outlining specifics such as what is being bought and at what price.
Given the speed of business in today’s world, use of a PO may seem cumbersome. However, purchase orders are key to setting expectations between parties, tracking orders, processing fulfillment, and serving as an audit trail.
Foregoing a formal PO process can open a company up to misunderstandings, unhappy customers, and potential liabilities.
Purchase orders are so important to business processes that most companies won’t take action on a customer's purchase until an authorized PO is received.
Sales teams routinely use purchase orders to confirm their client’s agreement to a purchase, and cannot get credit for a sale until the signed PO is submitted to their accounting department.
That said, POs can be very simple. One common purchase order example is when a restaurant waiter writes down your order on a pad of paper, and when it’s time to pay, hands you this paper as your check. In this case, the check is both your purchase order and your invoice.
Purchase orders can also look very different across businesses. The following purchase order sample from a travel company illustrates how the form was designed to the specific needs of this business, such as the importance of knowing the customer’s travel dates.
Purchase order vs. invoice: What’s the difference?
For the uninitiated, an invoice can be confused with a purchase order. Invoices are another common component of every business, but they’re not identical to a purchase order.
The difference between the two comes down to this: a purchase order is an agreement to buy while an invoice is a request for payment. These two documents are different sides of the same coin.
The PO is created and presented to the buyer once agreement is reached to move forward with a purchase. The invoice is generated by the vendor only after the purchase order has been fulfilled. At that point, the invoice is given to the buyer to collect payment.
The time interval between the creation of a purchase order and an invoice can span weeks or longer for large service contracts, or in e-commerce purchases, can take a matter of seconds.
What is a purchase order comprised of?
The purchase order form must contain specific elements to be complete. Some information may be optional, but these are the components every PO should include:
- Name of the vendor providing the products or services being purchased.
- Vendor’s business address and contact information.
- A unique purchase order number for tracking purposes.
- Date that the PO was created.
- Name of the buyer purchasing the products or services.
- Address and contact information for the buyer.
- Description and quantity of the products or services being bought.
- The agreed-upon price per purchased item.
- Date by which the purchased items are to be delivered.
- Payment information, for example, if the order was paid in advance or an invoice must be sent.
Optional info that can be added to a PO include any notes related to the order.
What does the purchase order process look like?
The steps in the purchase order process are standard for most businesses. Here are the typical steps in this workflow.
1. Purchase order creation
A customer agrees to buy a set of products or services from your business. It’s now time to document the specifics in the PO.
The purchase order can be created in a few different ways depending on your business model. For instance, an auto repair shop provides a PO only after they spend time with the customer’s vehicle to perform an inspection.
Typically, business-to-business (B2B) and service-related companies deliver POs either through the company representative who made the sale to a buyer, or via an accounting department that generates the PO to keep the process consistent and centralized.
Here, the purchase order template can take paper form, like those commonly seen when a plumber estimates repair costs and required parts, or a digital form that can be emailed then signed electronically.
For companies selling products online, the PO is generated automatically by e-commerce software as part of a customer’s checkout process. For example, Amazon displays its version of a PO just before buyers submit their order.
2. Acceptance by all parties
Once the PO is created, both the buyer and the vendor selling the items must review it. Any necessary internal approvals on either side happen at this point before agreement on the order can be reached.
For B2B transactions, this review must be performed carefully to assure the accuracy of the PO information before fulfillment takes place. This is because B2B transactions typically involve greater complexity and purchase amounts. Fixing an error can cost significant time and money.
Customers buying online are typically given an opportunity to review the PO before submitting the final order. The equivalent for in-person purchases varies based on the business. In the auto repair shop example above, the customer must sign the PO as an indicator of acceptance before work on the car begins.
If concerns are raised at this stage and the PO must be revised, a new PO will have to be created to replace the old one. Once the PO is finalized, a legal contract is initiated by the vendor and provided to the buyer. Because a PO is not a legal agreement, vendors typically like to provide the conditions of purchase and payment separately.
3. Purchase order fulfillment
After the PO and legal contract are signed by the buyer, the vendor works to fulfill the order. If an item listed on the PO is no longer available, both the vendor and the buyer must come together to determine an acceptable solution.
A separate PO can sometimes result from these scenarios, such as an agreement to provide the missing item at a later date.
The vendor uses the purchase order as the guide to deliver exactly what was ordered in the quantities and time frame agreed upon.
For example, I worked at an advertising company where the POs agreed to deliver ad campaigns with specific results, such as a guaranteed number of visitors to the website of a business, during a set period of time, like over a holiday weekend.
It is at this point, after an order is fulfilled, that a vendor may need to send an invoice to the buyer if payment was not already received.
4. Fulfillment review
Upon fulfillment of the purchase order, it’s up to the buyer to review the PO against the invoice, and confirm they received what was agreed upon. In the case of the advertising company I worked for, we provided campaign performance reports to clients confirming delivery of the PO parameters.
5. Purchase order archival
At this point, use of the purchase order is complete. The buyer and vendor can file away their separate copies of the purchase order. These POs are kept because they can be resurrected for several purposes, such as performing audits, planning budgets, and as records for tax purposes.
A word of advice about purchase orders
Although paper purchase orders are still prevalent, particularly among small business service industries such as electricians or plumbers, it’s worthwhile to transition to a digital system that generates the PO for you.
With purchase order software, such as Sage 50cloud Accounting, all POs become easy to create, and are shareable, trackable, and searchable. It streamlines costs because the software more than makes up for the time lost managing a paper system.
So digitize this important but administrative aspect of your business, and free up time to invest in your company’s growth.
About the Author
We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.