This post clarifies what a purchase order is, its components, and how it functions within commercial transactions. Whether you are a business owner, a procurement manager, or just someone looking to understand the basics of commercial transactions, I’ve tailored this post to help you understand the essentials of purchase orders.
Overview of a purchase order
A purchase order (PO) is a formal document issued by a buyer to a seller detailing the products or services agreed upon for purchase at specified prices.
Once the seller accepts the PO, it serves as a legally binding contract. The primary purpose of a purchase order is to specify the details of the business transaction, and it plays a crucial role in inventory management and financial planning.
Components of a purchase order
A typical purchase order includes several key elements. These elements provide clear instructions and details about the purchase:
- PO number: A unique identifier for the purchase order that helps in tracking and reference.
- Buyer and seller details: Names and contact information of both the buyer and the seller.
- Description of goods or services: Detailed descriptions of the goods or services being purchased.
- Quantities and prices: The quantities of the items being ordered and the agreed prices for each.
- Delivery date: The expected date when the goods should be delivered or the services completed.
- Shipping method: Information about how the goods will be delivered.
- Terms and conditions: Any additional terms regarding payment, delivery, or other contractual matters.
- Signature and date: Signatures from authorised representatives of both parties to validate the purchase order.
How purchase orders work
The PO process typically follows these steps:
- Purchase requisition: The buyer identifies a need and submits a purchase requisition to the purchasing department. A “purchase requisition” is an internal document that personnel use to request approval for purchasing goods or services.
- Supplier selection: The purchasing department selects a suitable supplier and negotiates the terms.
- Issue purchase order: Once the department selects a supplier and terms are agreed upon, the buyer issues a PO.
- Acceptance by seller: The seller reviews and decides whether to accept the PO. If the seller accepts the PO, it becomes a binding agreement on the PO’s. If the seller doesn’t accept the PO, there is no binding agreement. The seller may propose changes or decline the order entirely, potentially leading to further negotiations or the buyer seeking another supplier.
- Fulfilment of order: The seller prepares and ships the goods or provides the services as described in the PO.
- Receiving and inspection: The buyer receives and inspects the goods or evaluates the services based on the agreement.
- Invoice and payment: The seller sends an invoice matching the PO, and the buyer processes payment accordingly.
Importance of purchase orders
POs play a vital role in business operations for several reasons:
- Financial control: They help businesses manage their spending and budgeting more effectively.
- Legal protection: POs provide a legal document that clarifies the obligations of both parties.
- Record keeping: They serve as an essential record for auditing and tracking purposes.
- Inventory management: POs help in planning and managing inventory levels.
