Purchase Order (PO) : Full Form, Format, Types and Importance

What is Purchase Order?

PO is defined as a formal document that is used to order materials as required by the production department. Purchase Orders are issued by the purchasing or accounts department after the selection of the best quotation, a formal order is to be issued to the vendor. PO specifies all the details which are related to the material which is requested by the entity to the vendor. It is a written request sent by the entity to the vendor to supply specified material at specified rates and the intended date of delivery is also mentioned. Purchase Order is like a contract between the entity and the vendor for purchasing goods.

Geeky Takeaways:

• PO is the formal document that is used to order materials as required by the production department and sent to the vendor.
• Purchase order specifies the quantity, type of quality, prices, date of delivery, mode of payments, terms of payments, etc.
• Purchase orders can be issued for individual orders as well as for standing and repetitive orders.

Full Form of PO

PO stands for Purchase Order. Purchase Orders are issued by the purchasing or accounts department after the selection of the best quotation, a formal order is to be issued to the vendor. PO specifies all the details which are related to the material which is requested by the entity to the vendor.

Features of Purchase Order (PO)

1. Initial Document: PO is the initial document and the initial step of entering into business transaction. PO is the first official communication between the buyer and the vendor in a business transaction.

2. Contains All the Details: A Purchase Order contains all the basic and important details for placing an order with the vendor. Details which are included in a PO are quantity required, price, date of delivery, delivery location, payment mode, etc.

3. Legally Binding: A purchase order act as a legally enforceable contract between both the entity and the vendor. It is a written agreement between entity and the vendor about the prices and quantities of items PO has been issued. This protects both of there interest in event of wrong order, incorrect order, or cancellation of order.

3. Reporting and Analytics: POs help the buyer entity to keep track of all the purchase they have made, and helps to identify the inventory by matching it against the PO. Purchase order facilitate in analysing the vendor’s performance as well.

Format of Purchase Order (PO)

Here is the sample format of a general PO which is normally used in business operations:

PO here contains all the important details like:

• Address and communication details of Buyer
• Address and communication details of Seller
• Name of supplies required along with quantity and price
• Delivery address of the buyer
• Payment terms

Types of Purchase Order (PO)

The efficient management of purchases is vital for the smooth operations of any business, and purchase orders are very important to this process. For better management of purchases, same PO for all types of order may not be able to bring out fruitful results for the entity, so there are four different types of purchase orders that are used by different businesses for solving different purposes which are as follows:

1. Standard Purchase Orders (SPOs): A standard purchase order is used when businesses order something only for one time. Standard purchases order (SPO) are used when entity wants some goods or services infrequently, irregularly, or once after a long time. SPOs are also used this PO when they order things one time from different suppliers. One such instance of using SPO is when a new company needs to set up its office and requires tables, chairs, and other utilities, a SPO can be used to order them from a vendor.

2. Planned Purchase Orders (PPOs): Planned purchase orders (PPOs) are those PO which are well planned and essential for maintaining entity’s business operation pace. PPOs contains all the details of the product, delivery, and the cost is mentioned at which entity desires to purchase the material. However, the delivery and payment dates are tentative in case of PPOs. The distinct feature of PPO is that they are a long-term agreement committing to buy items or services from a single source.

3. Blanket Purchase Orders (BPOs): Blanket Purchase Order are very similar to standard orders but the difference is that there is less information in BPOs. BPOs are preferred by entities when the order time and order value is not clear or certain. The entity is aware about the type of material required but they are not sure how much quantity will be required. In a BPO, in some instances the delivery location and exact delivery date are also excluded, and item quantity and sometimes item prices are also not mentioned.

4. Contract Purchase Orders (CPOs): A contract purchase order (CPO) is like an agreement between the entity and a vendor. Under the agreement the terms of purchase, including the products to be purchased, payment, and delivery terms. This document is used to order products from the vendor. Also, CPOs are made under a set timeframe with an expiry date of agreement. All orders are placed on future requirements.

How Does Purchase Order (PO) Work?

Purchasing is a very peculiar task. In purchasing process, the engineering department or store send a purchase requisition to the accounts/purchasing department which is a list of desired material required by production department, in turn the accounts/purchasing department issues tenders or invite proposals from different vendors regarding purchase requested by the production department. After that the correct vendor is selected on the basis of quality and prices offered and then after the acceptance of best quotation, the purchase department has to issue a formal purchase order which is called PO. The working of PO involves,

• The entity makes a note of which products are required for their business operations, then chooses a vendor that offers those products.
• The purchasing department of the entity sends a PO to the vendor. This PO serves as a formal purchase request. It contains all the details regarding the delivery date for the product, as well as the pricing for all chosen items.
• Once the vendor gives the consent that they will be able to fulfill the order, they confirm this with the entity. The PO gets cancelled if the vendor fails to fulfill the order and the purchasing process is terminated.
• The Vendor prepares and ships the order, ensuring that they comply with the description specified in the PO and the delivery date as mentioned in PO. The PO number is included on the packing list for the entity’s convenience, as this helps them keep track of the new purchases.
• Entity receives the Order, and check whether it matches the desired description given to the vendor. Once the order is verified and the entity share the feedback with the vendor, Invoice is issued.
• Using the payment term and details in the PO, the buyer pays the invoice.

Importance of Purchase Order (PO)

1. Improved Planning and Budgeting: When entities have written paperwork for every purchase they have made, it becomes easier to keep track of what items have been bought, in what quantity, and at what price. This helps the account department to maintain a record of expenses, enabling them to budget more sensibly in the future and plan accordingly.

2. Acts as a Legal Contract: Purchase orders acts as a legal contracts between the buyer and the seller. It is important to document all the details about the ordered products because in case If the seller supplies a wrong or damaged product or demands a higher price, entity can use the PO as a legal document to protect their business interests. PO also protect the interest of the vendor, as he/she can use the PO as a reference to ensure that they supply the correct items and get paid in a timely manner.

3. Helps in Negotiations: PO helps the entity in maintaining a record of all purchases made, both the entity and the vendor can track the quantity of products ordered and the frequency of orders. With this information, entity can demand for bulk discounts on future purchases, which can save considerable amount of money in the long run for business.

4. Facilitates Efficient Business Operations: For running a business in a well-managed and efficient manner purchase orders are essential. PO can help the entity to ensure that they get the required items for the specified period. Entities can plan there business operations based on the terms of the supply, and track the performance of vendors they have worked with before. This saves the time and effort and enables the entity to focus on other aspects of there business.

Advantages of Purchase Order (PO)

1. Save Time and Effort: In the beginning, PO takes a bit of time but saves time in the long term. When the entity has established PO system it makes order purchasing very easy and smooth. For routine purchases the PO are extremely useful. PO also serves when the delivery arrives as, only thing entity is required to do is to ensure quantity is correct and as per PO and eliminates the hassle of long paper work.

2. Easy for Auditing: PO helps the auditor in verifying the details of purchase and helps in stock audit, as it enables auditor with all the documentation with details of quantity, price, date of purchase and other important details. This helps in eliminating discrepancies in financial information and reflects true image of entity’s financials.

3. Tracking Vendor Performance: PO helps the entity in identifying red flags in vendor’s performance. As using a PO, entity can ascertain which vendor fulfills there order on time and which vendor is behind the schedule. This will help entity to rate the performance of vendors and identity those vendors who perform on time delivery and at the end of the day adds value to the business operations.

4. Helps in Inventory Management: Using PO, an entity may track there inventory as they can track which orders have arrived the warehouse and which orders are yet to arrive, so the entity can ascertain the ideal stock turnover and without referring to different paperwork, can identify and match the inventory against the PO issued.

5. Provide Legal Protection: A purchase order act as a legally enforceable contract between both the entity and the vendor. It is a written agreement between entity and the vendor about the prices and quantities of items PO has been issued. This protects both of there interest in event of wrong order, incorrect order, or cancellation of order.

Disadvantages of Purchase Order (PO)

1. Time Consuming: Drafting of PO is time consuming as it will include different departments and many formalities are required by other departments before the drafting of PO. Also in case of a weak communication or any miscommunication, drafting of POs becomes more complex. Drafting of PO is not beneficial when the entity is in urgent requirement of any material.

2. Administrative Load: Creation of PO introduces extra paperwork which might be cumbersome for minor purchases or non-material transactions. It creates load on the purchase department as they have to be in regular touch within entity and outside the entity.

3. Cost: Drafting of PO is a costly affair for entities, as it will require paperwork and a dedicated team is required to be deployed for the purchase section. Purchase department has its own set of costs which they incur for making any purchase like advertisement for tender notification, etc. This creates financial burden on the entity.

4. Prone to Error: While drafting POs Errors can occur, either by the vendor or by the employee who raised the PO. Rectifying and managing the situation can be tough and to eliminate this, it is important to double-check the PO before sending it to the vendor and to periodically review the entire purchase order process.

Difference Between Purchase Order and Invoice

Basis	Purchase Order	Invoice
Purpose	A purchase order is a document sent by the buyer to the vendor, indicating a request to purchase specific products or services. It’s a formal order sent to the vendor.	An invoice is sent by the vendor to the buyer after the goods or services have been delivered or provided. It’s a request for payment and indicates what the buyer (entity) owes the vendor.
Timing	PO is Issued by the buyer before receiving the goods or services. It is the initial transaction to enter into business relationship with the vendor.	Invoice is issued by the vendor after delivering the goods or services, and before receiving payment. It is the final document indicating closure of transaction.
Content	PO Contains details like the type and quantity of items, agreed prices, delivery date, and payment terms, and payment mode details.	Invoice contains similar details as the purchase order but will also include information like invoice date, invoice number, due date for payment and Tax details.
Binding Nature	PO Becomes a binding contract once accepted by the vendor, even before any consideration changes hands.	Invoice represents a legal claim for payment. Once the entity (buyer) receives an invoice, they are legally obligated to pay the amount due to vendor.
Initiator of the document	PO is Issued by the buyer (in major case by Purchase department).	Invoice is issued by the vendor.