Chances are that if you’ve worked in, around, or with a mid-sized business, you’ve heard the term “purchase order” used when a transaction of some kind was being raised by the company.
Purchase orders are an important process control tool with many benefits relevant to businesses. They communicate requirements with suppliers, serve as protective legal documentation for both parties, and are important to have on hand for audit procedures.
More often than not, purchase orders only see extensive use in mid to large sized organisations, because the procedure used to create a purchase order can sometimes be time consuming.
That’s not to say that small businesses can’t make use of purchase orders by implementing a purchase order system to unlock the important benefits associated with using purchase orders.
Why do businesses use purchase orders?
This is often the first question asked by people who haven’t been involved in a business purchasing process before.
Purchasing is often taken for granted, because everyday transactions require no more than the swipe of a credit card in direct exchange of what’s being purchased.
Business to business (B2B) transactions pose more of a challenge due to the level of detail required in communication and documentation.
Purchase orders are used to initiate a transaction with a supplier when a business wants to purchase something. This allows both parties to have matching records they can use to verify what was purchased, the price of the transaction, and when the purchase took place.
Important details to include on every purchase order
Before integrating purchase orders into the purchasing process, it’s important to understand what details should be included on the document itself:
Name and Address of The Buyer and the Supplier
This allows both parties to verify who initiated the transaction, and that the order is being sent to the correct recipient. Addresses and other contact information can help to improve communication surrounding the purchase order in instances of confusion.
Delivery and Billing Address of the Buyer
The delivery address indicates where goods or services included in the purchase order will be delivered. The billing address indicates where the supplier will send an invoice to request their payment. Sometimes delivery and billing addresses are the same (in which case only the delivery address is specified), while other times a different address is provided for each.
Purchase Order Number
A purchase order number is used as both an internal and external reference number, allowing easy identification and traceability of the document. Sometimes companies that issue many purchase orders use one or more naming conventions to organise their purchase orders.
Issued On Date and Delivery Date
Including information about when the purchase order was issued provides a useful record for buyers to review when compiling spend reports, and for suppliers to confirm when the order was sent. The expected delivery date allows suppliers to verify time frames for planning their delivery schedule.
Item details provided on a purchase order should include item names, descriptions, and defined quantities and prices for each item. For complicated items, technical specifications are also sometimes included to provide further clarity.
Terms, Conditions, and Additional Instructions
Because purchase orders act as legally binding documentation, having clearly defined terms and conditions can help to settle disputes should they arise during the delivery of the order. In some cases, additional instructions are required to clearly communicate how goods or services specified in the order should be delivered.
Here’s an example of what a completed purchase order might look like:
The 10 Most Important Benefits of Using Purchase Orders
1. They provide more detail and utility than a basic expense record
Many companies simply document their purchases via basic expense records.
While filing basic expenses is a time efficient practice for many types of purchases, for more expensive and/or regularly ordered items, the benefits of using a purchase order can only be attained by adopting use of purchase orders during the ordering process.
2. They’re the foundation of a reliable purchasing process
By committing to using purchase orders, a business also commits to developing a purchase order process. This has its own set of benefits, which include improved cost control through structured approvals and better spend reporting, to name just a few.
In adopting a purchase order process, it’s also important to understand the benefits of using a purchase order system to facilitate that process. For most businesses, the decision to update the way they handle purchasing is closely tied to the selection of the system they use to manage it.
3. They improve organisation for multiple projects and processes
Purchase orders provide an effective way to document expenditures for different departments and projects as they begin and conclude. By using unique purchase order numbering conventions, orders can be tracked and filed according to their associated points of origin.
4. They provide clear and highly detailed levels of communication to all parties
When completed using the details listed earlier in this post, purchase orders contain all of the necessary details that all parties need to understand the requirements of the order.
Whether a supplier is reviewing the order to confirm the purchase, or a staff purchasing manager needs to approve the order before sending it to the supplier, the purchase order should be populated with the information necessary to answer any questions that arise.
When communicating requirements internally, sometimes a purchase requisition form is used. This article explains further the difference between requisitions and purchase orders.
5. They control the cost of ordered goods and services within a business
Purchase orders control the cost of ordered goods and services in many significant ways.
By defining the price of ordered items, buyers are able to avoid unexpected price increases, rogue invoices, and invoice prices which don’t align with an existing purchase order.
When purchase requisition forms are used, multiple purchasing requirements can be consolidated into a single, larger order, which can secure discounts from certain suppliers.
By using purchase orders, the cost of items can also be verified against standing budgets for projects and time frames, ensuring that approvals are granted before the order is released to suppliers.
6. They track the delivery, payment, and internal status of every order
The last thing any business needs are redundant duplicate orders for goods and services they don’t need. By tracking the internal status of purchase orders, duplicate orders are avoided.
Carrying out the purchase order process with an inventory control system, stock levels can also be referenced prior to placing orders.
Finally, when invoices are received against a purchase order, those invoices can be filed with the associated order to ensure payments are made on time and records are kept accurate.
In following this practice, the price of any received invoices can be confirmed by the purchase order.
7. They provide an excellent way to identify top performing suppliers
Purchase orders let businesses analyse and understand how they interact with their vendors.
By referring to details on purchase orders, vendors that are delivering on time, who are filling orders accurately, and who are providing prompt and accurate invoice records can be identified.
This lets businesses build a list of suppliers who are the most advantageous to work with.
8. They’re a critical source of information for compiling spend reports
Purchase orders and associated documents are the main source of information for compiling spend reports for review in a business.
Spend reports become increasingly important for businesses as they scale to ensure spending is controlled as order volumes increase.
Functions like cost forecasting (planning future purchasing costs) and cost control (ensuring costs to not exceed useful budget limits) also rely on purchase orders to ensure information is accurate and available for providing useful insights.
9. They can be used to provide accurate verification during financial auditing
During a financial audit procedure, having a reliable and accurate track record of all company spending is one of the most critical factors in confirming reasonable assurance to stakeholders.
While purchase orders aren’t the only document that’s needed to provide a complete audit report, by creating a purchase order procedure that includes proper documentation and reporting practices, the reliability of purchasing records will naturally increase.
10. They Provide Legal Protection
Purchase orders act as a legally binding document between the buyer and supplier.
If there are ever any disputes over what was purchased, such as the price, quantity, date of delivery, or other agreed upon terms, the purchase order serves as a verifiable record that either the buyer or the supplier can use to confirm the details of the transaction.
Purchase orders are used by businesses because of the increased need for clear communication during B2B (business to business) transactions, and because purchase orders are considered legally binding documents.
Purchase orders make it easier for all parties involved in a purchasing process to clearly communicate and reference the requirements of a given order.
Further reading on the advantages of using purchase orders:
Examples of Practical Purchase Order Benefits (From Loyola University)