What is a Purchase Order? Meaning, Format, Types, Example, How to Make it

Purchase orders play a fundamental role in a company's financial record-keeping. A purchase order serves as a means to track expenses and manage budgets and is a vital tool for maintaining effective supplier relationships. 

In this article, we will demystify the concept of a purchase order, delve into its various types, examine its standard format, and highlight its valuable advantages to businesses.

What is a Purchase Order?

A purchase order (PO) becomes a legal contract when the vendor agrees. It's like a written request to buy things or services from a vendor. It lists prices, quantities, when to pay, and when things should be delivered. The buyer's info is also there to make it official.

Importance of Purchase Orders in Business Operations

Purchase orders are of paramount importance for businesses due to the following compelling reasons:

Control and Accuracy

POs provide a structured way to procure materials, ensuring every purchase is approved and properly recorded. This helps avoid sneaky purchases, reduces mistakes, and ensures you get precisely what you want.

Cost Management

Businesses can negotiate better deals with suppliers when they use POs. Plus, POs guarantee that you only pay for what you've ordered at the agreed price – no surprises.

Inventory Management

POs are like a tracking system for your inventory. They help you see what you've got, where it came from, and when it arrived. This helps spot supply chain problems quickly and fix them quickly.

Cash Flow Control

POs are like budget checks. They ensure you have enough money to cover your purchases, preventing overspending.

Dispute Resolver

When there's a fight with a supplier, a PO is like a referee. It shows exactly what you ordered, how much you agreed to pay, and when you wanted it. This makes resolving disputes much easier and faster.

Types of Purchase Orders

Here are the four primary types of purchase orders that can streamline procurement and enhance efficiency:

Standard Purchase Orders

Standard purchase orders are the most common type for single, well-defined purchases. They contain detailed information about payment terms and delivery specifics, making them highly precise. Typically, these are employed for individual transactions with established delivery dates and payment conditions.

Planned Purchase Orders

Planned purchase orders are similar to standard POs but are used for more complex transactions. Rather than one-time orders, they lay out the entire scope of a transaction, scheduling payment and delivery in stages. This is useful for businesses that need to plan and break down purchases.

Blanket Purchase Orders

Blanket purchase orders are less specific than standard POs. They allow companies to request an unspecified quantity of a particular product or service over an undetermined period. It's an agreement to purchase, with specifics left open. These are often used for recurring purchases, simplifying procurement, and reducing administrative overhead.

Contract Purchase Orders

Contract purchase orders establish a commercial relationship between parties. They outline vendor details and payment or delivery requirements. These are typically used in long-term business relationships with an ongoing need for a specific good or service, formalising the arrangement.

Components of a Purchase Order

A purchase order is like a structured document with specific and crucial details. It typically comprises the following essential components:

• Purchase Order Number is a unique identifier that helps track the order throughout its lifecycle.
• Order Date marks when the order was placed, allowing for progress tracking.
• Delivery Date that indicates the expected arrival date for the ordered goods or services.
• Vendor Information featuring essential details about the seller, including their name and contact information.
• Ship-to Information that specifies the destination to which the items should be sent.
• Description of Goods/Services to comprehensively describe the items or services being purchased, including specifics.
• Quantity to state states how many of each item or service you intend to order, preventing confusion.
• Unit Price, which reveals the individual cost of each item or service, helps to calculate the total cost.
• Total Price, which is the total, gives you a clear view of the entire order cost.
• Payment Terms for explaining when and how you plan to make payments, including any applicable late payment penalties.
• Shipping Instructions to outline any special handling or shipping methods, such as specifying "fragile" or requesting bubble wrap.
• Additional Terms and Conditions for any extra rules or conditions pertaining to the order, ensuring that all parties agree.

How to Make a Purchase Order?

Purchase orders should be created using software that seamlessly integrates with the entire Invoice to Pay process. Here's a breakdown of what needs to be included:

Header

Create a header for your purchase order. Include your company's name, logo (if desired), and contact information. Also, mention "Purchase Order" prominently.

Purchase Order Number

Assign a unique purchase order number for tracking purposes. It's helpful if you use a consistent numbering system.

Issue Date

Write down the date when you're creating the purchase order. This helps in tracking and reference.

Vendor Information

Include the vendor's name, address, contact information, and other relevant details.

Shipping and Billing Addresses

Specify the shipping address where you want the goods delivered and the billing address for payment purposes.

Product Details

Fill up a table with columns labelled "Product Description," "SKU/Model Number," "Quantity," "Price Per Unit," and "Total." 

Delivery Date

Mention the expected delivery date for the goods or services.

Payment Terms

Clearly outline the payment terms, such as "paid upon delivery," "net 30 days," or any other agreed-upon terms.

Additional Notes

If necessary, add any special instructions or terms and conditions related to the order.

Footer

Include a footer with your company's contact information and relevant details.

Save and Share

Save the document with a descriptive name and share it with the vendor via email or other preferred means.

Purchase Order vs Purchase Requisition

Purchase requisition is an internal document generated by employees to request purchases. It serves as an in-house notification, signalling the need for materials within the organisation. On the other hand, a purchase order is an official order confirmation issued by the head of a department. It signifies the department's approval to procure materials from an external vendor.

Purchase Order Example

Let's consider a hypothetical scenario. XYZ Ltd. in Mumbai needs 100 office chairs with wheels at the agreed rate of 2,500 rupees per chair. They issued a purchase order to LM Furniture, also located in Mumbai. This purchase order specifies the required quantity, unit price, and other essential terms. Upon receiving the order, LM Furniture delivers the chairs on the agreed-upon date and sends an invoice for 250,000 rupees. XYZ Ltd. thoroughly inspects the acquired chairs, verifies the PO number, and settles the payment of 250,000 rupees within the 30-day payment terms outlined in the purchase order.

Benefits of Using Purchase Orders

Purchase orders offer numerous benefits for both buyers and sellers. For buyers, they serve as valuable tools for inventory tracking and purchase history management. Buyers can also place orders in advance without immediate payment. On the seller's side, purchase orders help with inventory management, track recurring charges, and provide peace of mind with a legally binding commitment from the buyer to pay once the order is fulfilled.

Conclusion 

Purchase orders provide security and legal protection for buyers and sellers, fostering trust in business relationships. By understanding the significance of purchase orders and their various components, businesses can optimise their procurement processes, minimise errors, and pave the way for smoother, more efficient operations.