What is a purchase order and how does it work?

A purchase order is an official offer you issue as a buyer to a seller. It’s a commercial document that indicates the types and quantities of products or services and their agreed-upon prices. Once a PO is accepted by the seller, it is a legally binding document.

A PO is like a shopping list that outlines the details of a transaction before it occurs. It details the items or services the buyer agrees to purchase at a predefined price.

The purchase order also includes payment terms and delivery details, among other terms and conditions.

While there are all kinds of purchase order templates out there, the primary components of a PO are:

• Buyer information: Legal name, address, and contact details of your company, i.e., the company issuing the purchase order.

• PO number: A unique purchase order identifier for easy tracking.

• Order date: The date you create the order.

• Shipping or delivery date: The date the seller expects to deliver the goods or services.

• Shipping method: Such as ground, sea, or air.

• Shipping terms: The shipping terms, such as “Free on board” (FOB) shipping point or FOB destination, indicate when the seller transfers liability and ownership of the goods to a buyer.

• Vendor information: Legal name, address, and contact details of the seller or supplier of goods and services.

• Shipping address: The address where you want the seller to send the goods.

• Billing address: The address the seller should use to invoice.

• Item descriptions: Details of the products or services you’re ordering, including a unique identifier or item number, the quantity of items, price per unit, and total cost.

• Order total: The total order price.

• Payment terms: The agreed-upon payment terms, such as net 30 or 60.

• Discount terms: Any discounts that apply to the order.

• Authorized signature: You’ll need a signature from whomever has authority to make the purchase, usually someone from your procurement or purchasing department.
  

Purchase orders are key for businesses to ensure authorized purchases, provide audit trails, and maintain financial control. Some types of businesses may not need the added formality of issuing purchase orders for their procurement processes. In fact, traditional PO processes can slow down certain operations. However, as companies grow, their purchasing needs become more complex, and POs can help improve your day-to-day operations.

Purchase orders provide an efficient, trackable way to manage the added complexity of scaling your procurement process flow. Considering nearly half of respondents (44%) in Amazon’s Global State of Procurement Report listed efficiency and complexity as a procurement challenge, it’s easy to see the need for any process that streamlines procurement.

POs help do just that and are indispensable to businesses because they:

• They provide a clear and concise record of all purchases, making it easier to track and manage spend and identify any discrepancies, which brings more transparency to procurement spending.

• By outlining the exact quantities of goods or services you ordered, purchase orders help businesses maintain optimal inventory levels and avoid stockouts or overstocks.

• A purchase order is also a legal document that outlines the terms and conditions of an agreement between a buyer and a seller, making them critical when resolving disputes.
  
  

Here are the typical steps for the purchase order process and key points to be aware of at each step.

Buyer creates a purchase order

The purchase order process begins when the buyer drafts a PO in a procurement system like Coupa or SAP Ariba based on a purchase requisition from one of the company’s departments. It could be an IT request to buy new computer equipment, or perhaps marketing wants to bring on an external design vendor. Most POs include shipping information, discount and payment terms, and the buyer and seller’s names and addresses.

Depending on the type of purchase order, a PO may also include a detailed description of each item, including its item number, price, and quantity. All POs also have a unique number (see image below), making it easy to track and reference them in the future.

Seller reviews the purchase order

Upon receiving the PO, the seller carefully reviews it to ensure everything aligns with their capabilities and inventory. They’ll typically double-check the item descriptions, quantities, prices, and delivery schedule for accuracy. If there are any discrepancies or concerns, the seller might request amendments to the PO or, in some cases, reject it altogether.

Seller approves or rejects the purchase order

If the seller finds the PO’s terms satisfactory, they will formally approve it. The approval process may involve logging into a procurement system and clicking an “Approve” button. Or, in organizations that use a manual process, approvers might sign a physical document or provide written approval via email. The approval transforms the PO into a legally binding contract, obligating the seller to deliver the goods or services as outlined.

If the seller finds the terms unacceptable, they might request changes or cancel the order. They may do this due to stock shortages, pricing disagreements, or other unforeseen circumstances.

Seller creates an invoice

Once the seller fulfills the order, they create an invoice. This invoice breaks down the total cost, including the price of goods or services, applicable taxes, and shipping costs.

It also outlines the payment terms, like whether payment is due right after delivery or within a specific timeframe (e.g., net 30). They’ll also typically add the PO number to the invoice so the buyer can easily match the details.

Buyer matches invoice to purchase order

When the buyer receives the invoice, they carefully match it against the original purchase order. This process verifies that the invoice accurately reflects the goods or services the buyer ordered and the agreed-upon prices.

The buyer and seller must resolve any discrepancies between the invoice and the PO before you — the buyer — approve the invoice for payment.

To spot discrepancies, you might try one or more methods of invoice matching, from a simple two-way matching (PO and invoice) to a more complex four-way match that also includes the receiving report and packing slip.

Some leading solutions like Brex offer AI-powered invoice scanning to auto-match an imported invoice to an open purchase order in your ERP via to further simplify the process and automate accounting.

Buyer approves or rejects invoice

If the invoice matches the PO and agrees to the terms, the buyer will approves it, creating a liability that goes into their accounts payable automation software and triggers the payment process. The buyer is now legally bound to pay the supplier as per the payment terms in the invoice and purchase order.

However, if there are discrepancies, the buyer can still reject the invoice and request corrections from the seller. One of the most important vendor management best practices is clear communication between both parties, so take extra care during this step to communicate any issues and establish a good working relationship.

Here are some of the key advantages POs can offer businesses of all sizes.

Improved inventory management

A well-organized purchase requisition and order system provides real-time visibility into incoming orders, modernizing inventory management. Better inventory management allows for effective stock-level planning and supply chain management, ensuring you have enough stock to meet customer demand.

Additionally, data-driven insights into future demand patterns help businesses make informed decisions about inventory levels to avoid overstocking or stockouts. Doing so can reduce inventory costs by as much as 10%.

Further, accurate monitoring of inventory levels enables businesses to make informed decisions about reordering and production schedules, which will help you minimize lead times, reduce carrying costs, and improve operational efficiency.

Enhanced vendor relationships

A digital or electronic purchase order system can ensure a positive working relationship with your important vendors. Companies that execute procurement through digital purchases reduce human error by eliminating manual processes, such as paper-based POs. This saves time and resources and will improve the accuracy and efficiency of high-volume transactions.

Other ways purchase orders improve supplier relationships are:

• Promoting accountability and facilitating proactive measures to address issues promptly, minimizing disruptions, and ensuring consistent order fulfillment

• Allowing suppliers to plan production and delivery schedules more effectively by providing greater visibility into upcoming orders

• Building trust and stronger relationships between businesses and vendors by reducing errors and ensuring accuracy

• Smoother transactions and improved communication thanks to enhanced mutual transparency

Additionally, digital PO systems often include features like built-in messaging that make for easy collaboration and communication between businesses and vendors.

Legal protection

Purchase orders will help you ensure fair business transactions. They establish legally binding contracts between buyers and vendors and serve as valuable legal protection for both parties in disputes or disagreements.

In this sense, a PO provides:

• Tangible evidence of the agreed-upon terms and conditions, such as the quantity of goods or services, pricing, delivery dates, payment details, and any special instructions or requirements.

• An official document and detailed record of the transaction help to establish both parties’ rights and obligations.

If either party fails to uphold their end of the bargain, the purchase order is fundamental for resolving disagreements. Key areas that POs will help you navigate include:

• Delivery disputes: If the vendor fails to deliver on time or uses a different channel, the buyer can rely on the purchase order as evidence of the agreed-upon delivery schedule.

• Quality disputes: If there are any issues with the quality of the goods or services, both parties can use the PO as a reference to determine whether the vendor has met the agreed-upon quality standards.

• Enforceability: Purchase orders are legally enforceable contracts. If the buyer and seller can’t resolve the dispute amicably, the aggrieved party can enforce the terms of the purchase order through legal action.

• Pricing disputes: Purchase orders help prevent misunderstandings about pricing by clearly stating the agreed-upon price for the goods or services before making an effective purchase.

Overall, purchase orders serve as legal safeguards for both buyers and vendors, helping both parties understand and adhere to the transaction terms.

Improved budgeting

Purchase orders are invaluable tools for budgeting. They offer a clear overview of upcoming expenses, facilitate accurate spend tracking, and allow businesses to exercise control over costs.

When a requisition or request for a purchase comes up, you can evaluate it against the established budget, enabling informed decision-making. This evaluation process presents opportunities to identify potential cost-saving measures, such as exploring alternatives, negotiating better terms, or deferring purchases.

For example, blanket purchase orders (BPOs) offer particular advantages in budgeting. BPOs establish a predetermined price for a specified time frame, regardless of potential fluctuations in market prices. This stability in pricing provides businesses with greater cost predictability, enabling you to plan and allocate resources effectively.

Purchase orders come in various types, each tailored to specific needs and often industries.

Standard purchase order (SPO)

The standard purchase order is the most common type for one-off purchases with fixed quantities and delivery dates. For example, a company that manufactures automotive interior parts might use an SPO to order a specific number of items from a supplier to cover production for a particular client.

Planned purchase order (PPO)

Like an SPO, a planned purchase order (PPO) outlines a future purchase but lacks a specific delivery date. Companies often use PPOs for recurring orders where the timing might vary, but the products, quantities, and qualities remain constant.

A manufacturing company might use a PPO to regularly order raw materials at a specified unit price while adjusting the delivery dates based on production needs.

Blanket purchase order (BPO)

A blanket purchase order (BPO) is a convenient option for companies that require regular deliveries of an item or service but are uncertain about the exact quantities or delivery dates beforehand.

This type of purchase order establishes a predetermined total quantity and unit price for the entire agreement, spanning weeks, months, or even a year. BPOs are particularly useful in industries with fluctuating demands or unpredictable usage patterns.

Let’s consider an example to illustrate the benefits of BPOs. A restaurant might use a BPO with a produce supplier to consistently stock fresh fruits and vegetables.

The exact quantities might vary depending on the seasonality of the produce, customer demand, or spoilage rates. However, by establishing a BPO with a fixed price for a set period, the restaurant can secure consistent supply at a predictable cost, eliminating the need to negotiate individual purchase orders for every delivery.

Contract purchase order (CPO)

A contract purchase order is a long-term agreement between a buyer and seller that establishes a framework for future transactions. It outlines the general terms and conditions, such as payment and delivery terms, for a series of purchases over time. However, it doesn’t specify products, amounts, or prices.

For example, an importer of medical goods could set a CPO with an international supplier to lock in payment terms, shipping terms, and conditions to accelerate purchases once they get an order from a client. When that happens, they simply issue a standard purchase order based on the standing CPO.

Brex is a comprehensive spend management platform that will simplify your purchase order management and bring more visibility and control to your procurement processes. By integrating with software like QuickBooks Online and NetSuite, you can use Brex to automate the entire PO process, from creation and approval to payment and reconciliation.

With Brex, you can:

• Integrate with accounting software: Effortlessly sync your PO data with your accounting automation software to simplify bookkeeping and reconciliation.

• Automate PO matching: Brex's bill pay software allows you to import purchase orders directly from QuickBooks Online and NetSuite and automatically match them to the right invoice.

• Manage discrepancies: If inconsistencies occur during the two-way matching process, you can inform users and push updates using Brex’s robust ERP integrations.

• Pay invoices: If everything matches, you can pay vendors directly from Brex. Brex also helps auto-populate the invoice details in a draft bill payment using LLMs that scan data from your invoices and read itemized lines for easier GL coding.

You can even use a Brex corporate purchasing card to automate routine purchases and bring PO-like processes to more of your business spending.

Purchase orders are fundamental procurement tools for businesses of all sizes. They improve inventory management, vendor relationships, and budgeting by bringing transparency, accountability, and legal protection to the purchasing process.

By embracing modern solutions like Brex, you can automate your purchase order process and free up valuable time for more strategic initiatives.

Ready to control your spending and unlock your business's full potential? Sign up with Brex and get started today.