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Dec 16, 2020

What is a Purchase Order and How to Create One

by Dor Beglaubter

Let’s talk about purchase order creation. 

Buying goods and services for yourself is pretty simple, both for you as the buyer and for the vendor. You know what you need, when you need it by, what the allocated budget is, etc. You can source the product or service from the right vendor and simply buy it. For the vendor, it’s simple too – he provides what you need, charges you for it, and you both live happily ever after.

When businesses or organizations buy things, it isn’t as simple. Firstly, establishing a need, getting approvals, and dealing with payments are often handled by different people, with time and gaps between interactions often resulting in communication issues and data loss. Secondly, payments themselves can have issues if invoices are addressed to the wrong entity or if the wrong vendor bank account is inserted in the system. On top of that, businesses need a clear audit log of what specific steps led to money getting spent – who did what, when, and why. Not only does this prevent misconduct and (in nightmare situations) fraud, it also helps companies achieve certifications and go through successful mergers and acquisitions. Even going public requires a proper audit log.

However, with the right practices it is possible to overcome the challenges of business procurement, and purchase orders are key. Let’s dive into the good old PO process; learn what POs are, how POs work, as well as how and where POs are created. In short, in just a few minutes, you’ll be up to PO speed!

What is a Purchase Order?

A purchase order (PO) is a legal document sent from the buyer to the vendor which authorizes a purchase of goods or services. The purchase order details what’s being purchased, for what amount, in what quantity, and also expected dates (or time frame) and place (or places) of delivery. The PO document is legally binding, but more importantly, it helps both sides of the transaction log deliver and streamline the purchase. Who creates a purchase order? A purchase order is created by the buyer after the purchase request is approved. It is then sent to the vendor or supplier. 

There are 4 types of purchase orders: 

  • Standard purchase orders – these are the most common POs, and they reflect a situation in which the buyer knows exactly what they’re buying, the cost, quantity, delivery date and place.
  • Planned purchase orders – these are used when the buyer knows what they are buying and for what cost (per item), but the quantity and delivery date is still unclear, and therefore, estimated.
  • Blanket purchase orders – these can be used to negotiate better pricing or secure stock and delivery dates in advance. Planned POs and blanket POs are often used interchangeably, for example in the case of consultants, law firms etc.
  • Contract purchase orders – basically, this is a standard purchase order with a signature page, which is sometimes used by large enterprises that look to be extra safe. You won’t typically come across many of these.

Let’s focus on standard purchase orders for now.

PO Steps & Flow

  1. The purchase is approved on the buyer’s side
    If the business deploys a proper procurement process, the purchase order creation should be the result of a purchase request (or requisition) going through an approval process. The approval process will usually start with the requester’s manager, and depending on the purchase’s amount, type, and sensitivity, may require additional approval from other stakeholders (budget owners, legal, security, and finance teams).
  1. The buyer sends the vendor the purchase order
    Once the purchase order creation is done, the buyer sends it to the vendor either via email, or automatically using the business’s PO or ERP system. The vendor should acknowledge receipt of the PO so that the business knows everything is on track.
  1. The vendor fulfills the order
    The vendor should now supply the goods or services according to the details listed in the purchase order. At this stage, the vendor will send the buyer the invoice which reflects the PO. Usually, the business would mark ‘Goods Received’ on the purchase order’s line items, which will later be used by the business’s AP department for what’s called ‘3-way matching.’
  1. The buyer pays the vendor’s invoice
    The business processes the invoice, and pays the vendor based on the payment terms, which are also dictated and listed on the purchase order.

How to Create a Purchase Order?

Creating a purchase order will usually be conducted over a digital system, which either contains or automatically generates most of the purchase order’s information. Using digital systems is the only way to really scale procurement operations, and without it a business will quickly get lost in piles of unorganized papers. 

A purchase order needs to contain the following information:

  • PO number – this is a unique number that allows both sides to easily find and log the PO
  • Buyer details – formal name and address
  • Vendor details – formal name and address, contact information is often added
  • Shipping address – the address to where the goods will be shipped. If a service is covered in the PO, this will be the buyer’s address
  • Line items – list of items which include their
    • Item name
    • Item ID
    • Item description
    • Quantity
    • Discount
    • Unit price
  • Subtotal – total cost, including shipping cost, minus discounts. Tax is added, if applied

Here’s an example of a purchase order: Feel free to download our PDF and Word templates :-).

Methods to Create a PO Using Accounting, ERP, or PO Systems

Purchase orders are important to both businesses and their vendors. They help streamline the enterprise procurement process, add a layer of assurance to the transaction, help both sides stay organized and deal with challenges when those arise. So now that you’ve decided to start a purchase order process, where should start your purchase order creation?

Word doc or PDF – using one of the widely available templates, you can customize your own PO and start sending them right away. However, it may become challenging to deploy the other parts of the PO process, such as requisition approvals,invoice matching, and generally keeping everything organized. 

Accounting tools – some accounting software like Quickbooks can be leveraged to generate purchase orders. Creating POs in Quickbooks is a good option if you’re a small business looking to introduce some order into your purchasing, but for larger organizations, it likely won’t scale.

ERP – enterprise resource planning software always comes with a PO module which can be leveraged to create POs. Generating POs on the ERP, as you do other important financial processes, is good practice However, ERPs are often technical and complex, making the purchase approval and ‘goods received’ steps of the process hard on employees.

Purpose built PO tools – these systems use the best of both worlds; they have a simple interface for users to create purchase requests, for approvers to approve those requests, and upon approval, they create purchase orders which can be configured to be sent automatically to the vendor. Some PO tools offer additional financial capabilities like invoice and payment automation, however most enterprises prefer to keep those purely financial processes on the ERP.

Any business can recognize the true value in purchase orders.  This important documentation  helps both businesses and their vendors stay on top of their procurement processes, close any time or money wasting gaps, and work better, together.

Interested in implementing a spend management system that simplifies and streamlines your business’s existing process? Check out Approve.com and request a free demo today!

Interested in implementing a spend management system that simplifies and streamlines your business’s existing process? Check out Approve.com and request a free demo today!

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