What is Purchase Order (PO)? | Definition, Types and Benefits

What is Purchase Order (PO)?

A Purchase Order (PO) is a formal document issued by a buyer to a seller authorising the purchase of specific items at specific quantities and an agreed-upon price. It details everything, including items, quantities, agreed-upon prices, payment and delivery terms. Once the seller accepts the Purchase Order, it turns into a legally binding contract.

ERP software such as Sage X3 automates the generation of a Purchase Order, enabling your employees to focus on more productive operations and ensuring your stock never drops below the safety stock limit. Businesses can generate both automated (demand-driven) and manual POs with pre-configured vendors and items.

Different Types of Purchase Orders

There are five types of Purchase Orders, namely Standard Purchase Orders (SPO), Digital Purchase Orders (DPO), Planned Purchase Orders (PPO), Contract Purchase Orders (CPO), and Blanket Purchase Orders (BPO).

1. Standard Purchase Orders (SPO)

A Standard Purchase Order (PO) is typically used for predetermined requisitions. It consists of a PO Number, dates, buyer & vendor information, item description, payment & shipping terms, and other information. It is printed in a standardized format and is treated as a legally binding document.

2. Digital Purchase Orders (DPO)

A Digital Purchase Order is an electronic document that replaces the traditional paper-based purchase requests. There are several benefits of a Digital Purchase Order. It improves speed, accuracy, tracking, and compliance. Moreover, it enables businesses to maintain financial discipline through pre-approved budgets.

3. Planned Purchase Orders (PPO)

A Planned Purchase Order (PPO) is a purchase order with tentative delivery dates and a long-term commitment to purchase specific quantities of specific items at a specific price. It is best used for bulk, recurring, seasonal, and uncertain timelines where the buyer adds delivery dates at a later point in time.

4. Contract Purchase Orders (CPO)

A Contract Purchase Order (CPO) is a long-term commitment by a buyer to a seller with a single contractual framework for multiple transactions. It enables buyers and sellers to transact repeatedly under predefined contractual terms, serving as a master agreement that governs rules pertaining to pricing, quantity thresholds, and invoicing conditions.

5. Blanket Purchase Orders (BPO)

A Blanket Purchase Order (BPO) is a long-term agreement that combines many small orders into a single large agreement, typically preferable for buying recurring goods and services. In this type of PO, the agreement period is typically six months to a year, and spend limits are clearly specified.

How to Create a Purchase Order?

A streamlined purchase order process ensures that every small or large purchase made by the company is systematically done, without creating any confusion among the stakeholders within and outside the company. The objective is to create a standardized procedure for procurement to improve efficiency and achieve complete visibility into the purchasing process.

Here are the necessary steps followed while generating a purchase order.

1. Creating Purchase Requisition

A purchase requisition is a purchase request document generated internally within an organization by a staff member who wants to procure goods or services for the organization. ERP software solutions offer an effective way to create this initial purchase requisition document including the details of items to be bought and the reason for making the purchase, allowing senior staff to review the purchase request.

2. Generating Purchase Order

After the senior team members review and approve the purchase requisition request, the authorized staff generates a purchase order using procurement software , which consists of the PO number along with all the necessary details regarding the purchase, including buyer company name, product names, quantity, prices, seller name and shipping address, and is forwarded to the seller.

3. Approving Purchase Order

On receiving the purchase order, the seller goes through the details listed in the PO and communicates and reconfirms with their production department before giving final approval to the buyer on their ability to fulfil the order on time. At this stage, the supplier is free to request the buyer for modifications in the terms and conditions, before finally accepting, which becomes legally binding on both parties.

4. Recording PO Number

Once the seller officially accepts the purchase order through email or any other acceptable mode of communication, the buyer moves ahead and records the PO number in the system. Soon after the order delivery, the purchase order is marked fulfilled. Every stage of the PO is automatically recorded by the ERP system, thereby enhancing efficiency and reducing manual errors in the ordering process.

5. Order Approval

The order fulfilled by the seller is reviewed and approved by the buyer. On approval of the goods or services received by the buyer, the seller generates an invoice. Matching of the purchase order no and invoice ensures a smooth payment to the supplier. Eyeing long-term strategic partnerships, many companies utilize accounts payable software to manage multiple suppliers effortlessly.

Key Components of a Purchase Order

A Purchase Order (PO) contains a PO number, order date, buyer & supplier details, and order & pricing information. Here are its components:

1. Identification and Dates

• PO Number: A unique reference number for the Purchase Order
• Order Date: Date of the generation of the Purchase Order

2. Buyer and Supplier Details

• Buyer Info: Name, address, phone number, and email address of the buyer
• Supplier Info: Name, address, phone number, and email address of the supplier

3. Order and Pricing Information

• Item Description: List of the products and services, product codes, and model names
• Quantity & Price: Units ordered and agreed-upon price
• Delivery Location: Delivery location of the goods
• Payment Terms: Payment terms (such as upfront payment, partial payment, due on receipt, etc.)

Also read, Role of ERP in manufacturing

What are the Benefits of a Purchase Order (PO)?

1. Enhance Productivity

Purchase order provides you visibility into the procurement process, allowing you to track products that were ordered and also avoid order duplication. An online purchase management system further automates the ordering of products that are regularly required by the organization, by automatically generating a PO when the inventory reaches a minimum threshold level.

2. Manage Inventory

Purchase orders allow you to efficiently track and plan your inventory, especially when you use just-in-time inventory strategy to minimize your holding costs. PO helps you to view what is due for reordering and also plan future inventory requirements.

3. Track Suppliers

Purchase orders are effective documents to sort and filter information about multiple suppliers a business is dealing with daily. It further helps you to prevent order delays and make sure that suppliers follow order fulfilment timelines.

4. Centralized Record

Whether it is a purchase requisition or purchase orders created by an ERP system, everything is stored in a centralized repository, giving you access whenever you need to track the items. Acting as a permanent record of all the purchases made by the business, it even helps you to perform cash flow projection.

5. Monitor Liabilities

Purchase order PO allows businesses to track every expense whether it is planned or unplanned and make sure it is recorded in the current liabilities to effectively manage their cash flow statement. Monitoring the cost of production becomes simpler as purchase orders include details on pricing which can be used to calculate raw material inventory cost even before actual delivery.

Difference Between Purchase Order, Invoice & Sales Order

A purchase order is a purchase request document issued by the buyer to the seller, listing details about items, quantities, prices, etc. After receiving the purchase order, the seller issues a sales order to the buyer as a formal acceptance of the purchase request and initiates the order fulfillment process. Once the goods have been delivered to the buyer, the seller issues an invoice to the buyer to request payment against the purchase order. 

Conclusion

A purchase order is a legally-binding document with a unique purchase order number, generated by a buyer confirming the purchase of goods to the supplier, who can then make adequate arrangements to supply goods as specified in the order. Creation of a standard purchase order starts with a purchase requisition request and ends with order approval by the buyer.

Sage X3 ERP with its robust built-in capabilities allows buyers to streamline their ordering process, helping you generate a specific purchase order type with custom terms and conditions, and managing and tracking multiple POs for various suppliers and vendors. Thus giving you absolute control over your procurement and ordering process while reducing administrative burden and costs.

Purchase Orders (PO) FAQs

1. What is a PO Number?

A Purchase Order (PO) Number is a unique reference code generated by a buyer and assigned to a Purchase Order. This is done automatically using procurement software. Generating a PO Number helps the buyer track purchase orders, verify goods received, and ensure compliance. During order fulfilment, the supplier generates an invoice with the relevant PO Number printed on it.

2. What is the difference between a Purchase Order and an Invoice?

While both the Purchase Order and Invoice contain similar information, they serve distinct purposes. A Purchase Order (PO) is generated by a customer for order placement purposes. In contrast, an Invoice is generated by a seller for payment for goods or services with credit terms. A PO is generated during the pre-purchase time, and an Invoice is generated upon product shipment or during the performance of the service.

3. Why Do Companies Use Purchase Orders?

A purchase order is a formal document issued by the buyer that helps track incoming inventory, including items, prices and quantities. It makes sure that all purchases are made within budget. PO also serves as a useful tool for tracking past purchases by creating an audit trail as well as ensuring better cash flow visibility to plan future purchases.

4. Which is the best software for creating and managing Purchase Orders?

Many basic accounting software programs support Purchase Order generation; however, a comprehensive ERP software, Sage X3, stands out. Here’s why:

• Streamlines Workflows: Sage X3 eliminates the need for manually typing POs. You can specify inventory reorder thresholds once, and it will automatically draft POs without manual intervention.
• Automated Routing: You can customize conditional routing preferences, and it will route the POs automatically.
• Deep Integration: Sage X3 deeply integrates with your organization-wide processes, including procurement, production, inventory, and supply chain.
• End-to-End Procurement Management: Multi-warehouse tracking, vendor performance evaluation, and Purchase Requisition Management.
• Budgeting & Financial Planning: Comprehensive financial planning, budgeting, and forecasting capabilities.