Businesses provide goods and services to each other using a system which involves purchase orders, sales orders, and invoicing. Essentially, a purchase order is a list of goods and services which are provided by a vendor, along with their prices and the quantities which the vendor's customer wants to purchase.
The purchase order (often abbreviated as “PO”) document is initiated by the purchaser and received by the business providing the goods and services. In return, the supplying business responds with a sales order which confirms that the order has been received and that they have reviewed and accepted the request.
An invoice is then generated thereafter by the supplier - or in other words, a formal request for payment of the goods or services which are to be, or have been, delivered. Other documents which are relevant in this sales cycle include delivery notes, which are generated when goods have been delivered to their intended recipients, and receipts which acknowledge payment.
This article is only focused on purchase orders (if you want to learn more about everything else, check out the rest of our blog).
Purchase orders often come with terms and conditions.
It's important to understand what these terms are and the purpose they serve.
To get started, a practical and extensive example of how purchase order terms and conditions are typically defined is available for review - outlined by the University of Toronto.
The Purpose of Terms and Conditions on Purchase Orders
There are several situations which may arise as a source of dispute between a buyer and a seller after a purchase order has been made but prior to the delivery of those goods and services.
Typically, an individual or business looking to make a purchase will inquire about the availability of goods and services with a supplying company. The supplier could either generate a quotation or provide a price list of the available goods and services.
When the purchaser is aware of what the supplier has on offer and at what price, they then create a purchase order which, when accepted by the supplier, becomes legally binding.
Another way a purchase order becomes legally binding is if the supplier provides the ordered goods. The buyer then has the obligation to make a payment.
While the phrase “legally binding” may seem intimidating, agreements like these keep businesses safe by protecting the interests of both parties - one of the many benefits of using purchase orders.
Additionally, it's always important to note that most businesses are always willing to discuss and resolve contract issues verbally, rather than taking expensive legal action.
Essentially, all purchase orders become contracts once they're accepted by the supplier. This means that once a supplier has reviewed and accepted the terms and conditions in the purchase order by either signing off or expressing acceptance, they are bound legally to fulfill these. Important terms included in a purchase order specify the following regarding this trade agreement:
- Quantities of the goods to be sold and/or specifics about a service to be provided,
- The prices at which said goods or services are to be provided, including any discounts, and specifics about the parties responsible in regard to shipping, taxes, tariffs and other costs which may be incurred,
- Delivery dates, times and methods and,
- Payment terms.
Each of these elements comprising a purchase order afford protection for both the supplier of goods and services as well as the buyer. Should any of these terms be modified by the supplier, this does not constitute an acceptance.
Protections Afforded to Sellers/Suppliers/Vendors in the Purchase Order
On the supplier side, providing certain goods and services could require upfront costs, such as ordering inputs. If the supplier incurs costs in producing the ordered goods or in preparation for providing a service, these could be sunk costs. This is to say the supplier may be unable to recover these costs should the buyer make changes or cancel their order after the purchase order has been received and accepted. In such a case, buyers are bound to the payment schedule as specified on the purchase order, regardless of whether they actually need the delivery or not.
Additionally, if the purchase order terms and conditions specify that certain transit costs are borne by the buyer, then the supplier could be protected from breaching the contract if these payments are not made in a timely manner. An example is a purchase order regarding a shipment of goods abroad.
Typically, suppliers have a good understanding of the costs involved in shipping their products to markets abroad. To simplify the process for consumers or customers, they often provide price guides inclusive of any tariffs or customs duties involved with the delivery process. Additionally, they will typically factor in the costs of delivery.
However, tariffs imposed on certain types of goods or goods from a specific country could change overnight, (sometimes depending on the mood of one country's leadership). A shortfall in the required payments for a shipment could initially be borne by the supplier but ultimately added to the invoice to ensure timeous delivery.
When these costs are substantial, buyers may be required to pay their own custom duties.
A delay in payment due to unexpected changes may result in a supplier failing to meet the required delivery times. If this is the case, a supplier can cite the purchase order as a legal defense for their failure to deliver a product on time because the fault would lie with the buyer's failure to make the required payments. This also applies if there are sudden significant changes to transportation costs meant to be paid for by the buyer.
A list of possible (but not limited to) example supplier purchase order terms and conditions from a real company is available for review here.
Protections Afforded to Buyers in the Purchase Order
Among the most important details included on a purchase order are:
- Product descriptions
- Dates of Delivery
For both businesses and individuals, it is of paramount importance that the product which was ordered is the one that is delivered.
Getting products with the wrong specifications could have significant consequences, particularly for businesses which may have their own contracts to honor.
A purchase order binds suppliers to the delivery of the specified products or services to the specified location and at the specified times.
There are also situations whereby, because of changes in tariffs, transportation and other input costs, that suppliers may have to produce or provide the specified goods or services at a cost higher than anticipated. If a buyer's purchase order has already been accepted, a supplier cannot then demand more payment for the specified goods or services merely because they experienced price changes in their supply chain.
Purchase Order Modifications or Cancellations
As discussed, once accepted, purchase orders are legally binding.
However, both suppliers and buyers have circumstances in which it is clear that cancellation or modification is the simplest way forward.
Using the previously mentioned cases as reference could provide clear examples.
If a supplier with stock on hand accepts an erroneous purchase order - for example - if a customer orders 20 items instead of two and realizes their error, it is often advantageous for both parties to agree to a cancellation.
Additionally, this could be a clause in the purchase order highlighting that clearly erroneous orders may be cancelled without consequences if no costs have been incurred by the supplier
A common example is implemented by Uber Eats, which allows for a full refund if an order cancellation is processed prior to a restaurant beginning to prepare a meal.
Modification may include the material changing of one or more of the terms and conditions within the purchase order.
For example, a supplier may typically offer free delivery to a given residential or address. In some cases, one may offer to pick up the items at a warehouse or on company premises and this may be accepted by the supplier regardless of their standard practices or terms in the purchase order.
Finally, if there is a material issue with any purchase order, a supplier could cancel it and issue a refund. However, it may not always be the case that a refund is available.
Sticking with the Uber Eats example, ordering alcohol requires confirming that one is over 18. If an adult cannot accept the delivery and it turns out the recipient is a minor, this constitutes a material breach. The supplier's representative can refuse to complete the delivery and the supplier may be under no obligation to provide a refund.
Drafting and Sharing Contracts Digitally
With a clear understanding of why it is advantageous to ensure that all parties understand their rights and obligations with each purchase order, it becomes obvious why utilizing digital tools and systems which allow the sharing of purchase order terms and conditions prior to their becoming legally binding would be a benefit.
Not only does it reduce the exposure due to miscommunication, but an easy-to-understand platform which highlights any significant changes to a purchase order allows for faster communication and saves significant time.
Purchase orders raised using digital software platforms are just as protective as a traditional contract, except with added functionality.
Finally, not all general purchase order terms and conditions apply to every business or purchasing agreement. Utilizing standard templates to draft all formal purchase order agreements could leave out crucial terms which protect your business or yourself as a client from needless legal exposure.
Using a standardized purchase order process and procedure to establish terms and conditions is considered a best practice in many organizations.
The use of a purchase-to-pay processing system allows agreement terms to be communicated and stored efficiently and effectively through the ability to store unique sets of agreements with different suppliers.
Fast track your way to PO mastery - explore more articles about procurement management!