What is a Purchase Order?

Everything You Need to Know

An image showing a construction worker delivering a purchase order to a businessman.

The world of supply chains begins with a single document: a purchase order. Before shipments are sent in large vessels across the ocean, or even packaged into multimodal containers, companies must first kick off their logistics endeavors with this piece of paper. Afterwards, many other documents will follow (from an Invoice to the Bill of Lading). But, the entire journey of supply chain management begins with a purchase order, making it crucial to understand its goal, importance, and relevance to the overall process to transport products across long distances.

What is a Purchase Order?

A purchase order is a document through which a buyer requests a set of goods to a supplier or vendor. It is the start of a commercial interaction in the world of supply chain logistics, and the initial discussion between both parties. It is also the beginning of the procurement process—i.e., how companies secure the goods they intend to use.

Broadly speaking, we can think of a purchase order as a question from the buyer to their supplier. The buyer, in need of certain goods, contacts their suppliers asking if they have the goods in question in stock. You might be wondering: couldn’t this be a phone call or an email? And yes, in many cases, companies interact with suppliers in informal ways before placing an order. But when companies grow larger in size, they are likely to interact with a large number of suppliers—sometimes in the hundreds or thousands. In such cases, handling multiple conversations would require a large staff whose sole purpose would be to manage supplier relations. Instead of spending so many resources on interactions with suppliers, companies can streamline their process by creating a Purchase Order that outlines, in a single document, the products they wish to purchase.

But Purchase Orders bring far more than formality to an interaction between buyers and suppliers, You see, a Purchase Order is also a legally-binding document similar to a contract, through which a buyer is asking a supplier if they have certain goods with the explicit intention of acquiring them. If, for some reason, the buyer were to back out of a purchase halfway through the process, a supplier could use a Purchase Order to defend their interests in court. Similarly, if a supplier delivers a different set of goods than those confirmed in a purchase order, the document could be used against them in a legal dispute

“A purchase order is a document through which a buyer requests a set of goods to a supplier or vendor”

What’s a PO.?

PO is the most broadly used acronym for Purchase Order in the world of logistics. Since companies are likely emitting hundreds of Purchase Orders a month, it has become standard practice to refer to them through this acronym. Thus, “PO” and “Purchase Order” are the exact same term and can be used interchangeably.

How Does a Purchase Order work?

There are five broad steps that need to be followed for a Purchase Order to work. These might vary across industry and, in many instances, specific suppliers or buyers might have intermediary steps that help them streamline their own logistics processes. But, in general, purchase orders will follow these general patterns.

The Logistics Process around a Purchase Order

A diagram showing all the steps related to fulfilling a Purchase order. These are: a buyer sending the Purchase Order to their supplier, the supplier accepts the Purchase Order  based on supply, the supplier delivers goods, the supplier gives an invoice, and the buyer pays an invoice.
(Diagram made by Auba)

Roughly speaking, we can think of a purchase order as a document that provides an initial signal and elicits a response. The signal in question refers to the goods a company needs at a given moment, whereas the response comes from the suppliers who must respond by saying whether they have the goods in question or not.

Thus, the first step in a purchase order’s life has the buyer examining its inventory to determine which goods it needs. Afterwards, it makes the document itself based on the products it wishes to acquire. The document is then sent to the supplier, initiating the entire process around a purchase order. In the Purchase Order, the buyer outlines all the products it needs from a supplier and the quantities it wishes to be delivered immediately. At times, a buyer might ask for a large quantity of goods to be delivered over a year, requiring just a subset to be delivered immediately.

Upon receiving a Purchase Order, a supplier must then look at its existing stock of goods to ensure it can deliver the products being asked for by the buyer. If the supplier lacks the goods in question, it must communicate it to the buyer, likely putting an end to the process. If, instead, the buyer does have the goods in stock, it can accept the purchase order in question. Thus, a relationship between both parties is born.

Once a supplier accepts a purchase order, it must begin all the internal processes necessary to deliver the products agreed upon to their buyer. This implies moving products within their warehouses, consolidating them into a vehicle, and ensuring the goods are transported in time to the buyer. The transport of the goods is a different topic altogether that happens roughly at the start of the relationship. Both buyer and supplier must come to an agreement on who is responsible for the transport of the products in question ranging from having full responsibility on the buyer (commonly known as Ex works) to full responsibility on the supplier (commonly known as Delivered Duty Paid, or DDP) or any point in between. These agreements are referred to as the “Incoterms” of a commercial relationship and merit an essay on their own. For our current discussion on purchase orders, it suffices to say that the inconvenience—i.e. the responsibility of transporting goods—is agreed upon by buyers and suppliers at an earlier stage.

Upon completing the delivery of goods to a buyer, the supplier is then able to issue an invoice for them. In this invoice, it specifies the price for the goods that was previously agreed upon, signaling an obligation towards the buyer to cover the costs of the goods it has just received. Similar to the Purchase Order, the Invoice is also a legally binding document between the two actors which requires a further action from the buyer: the payment for the goods delivered. 

Finally, once the products are in the hands of the buyer, and the supplier has issued an invoice, all that remains is for payments to be processed. In this last step, the buyer acknowledges the invoice from the supplier and pays it in full for the services provided.

What is in a Purchase Order?

A Purchase Order contains two important sets of information, both of which are crucial for the logistics process. First, it contains the information of the buyer making the purchase order in question. This allows the supplier to have all relevant contact details from the buyer while also certifying the buyer in question is a legitimate entity. It must also contain the needed information for internal use, such as a Purchase Order number that can help easily identity the order in question.

Second, it contains all the information from the provider as to outline both parts included in the agreement. Afterall, we should not forget a Purchase Order is a legally binding document.

Finally, a Purchase Order must contain a list of all the goods it needs from a supplier as well as the quantities requested for each one of them—similar to how a grocery list works. Moreover, it includes the prices to be paid for each unit of a good as well as the total price for the quantities being ordered.

What is a PO number?

A purchase order number (also referred to as the PO#), is a code assigned by a buyer to each purchase order it creates. The purpose of these numbers is to have a clear and simple way to track shipments internally without having to look at conversations with specific vendors or long email chains.

In general, a PO# will be a set of numbers or characters created by the company and placed in the Purchase Order itself. While there is no international convention on how companies should assign Purchase Order Numbers, they must do so in a way that ensures they will have unique values each time. This can range from a simple count increasing in value for each new Purchase Order to a software randomly creating POs as strings of characters. The only non-negotiable is that a PO# should not be repeated by a company in order to avoid confusions.

What is the Difference Between Work Order and Purchase Order?

Although a purchase order and a work order have similar names, they are intended for different purposes. A purchase order is a document through which a supplier inquiries to a supplier about the availability of a material good—think of physical objects like steel, motors, or cars. A work order, on  the other hand, is a document through which a buyer asks a provider about their ability to deliver a given service—this includes staffing an event, providing security, or even cleaning services. Thus, while both a purchase order and a work order have the explicit purpose of enquiring about availability, the former focuses on products while the latter focuses on services.

What is the Difference Between Purchase Order and Invoice?

While both the purchase order and invoice are legally binding documents in the logistics process, they serve different purposes. On the one hand, a Purchase Order is an initial inquiry from a buyer to a supplier about the availability of goods for purchase. On the other hand, an invoice is a request for payment from the supplier upon delivering the goods to the buyer.

A simple way of differentiating a Purchase Order from an Invoice is to think of the person creating the document and its intended audience. A Purchase order is made by the buyer to the supplier, while the invoice is made by the supplier to the buyer to request a payment. As you can see, the relationship between both terms is inverted, serving as a useful reminder of their differences.

Difference between Invoice and Purchase Order

A diagram showing the relationship between a buyer and a supplier in terms of the documents they issue. While the supplier makes an invoice for the buyer, the buyer makes a purchase order to the supplier.
(Diagram made by Auba)

So, what is the purpose of a Purchase Order?

In the end, a Purchase Order is meant to simplify and formalize the logistics process for companies. It allows them to request goods from suppliers in an efficient manner while providing legal backing in case it is necessary. Most importantly, their mere existence streamlines the logistics process to ensure companies can engage with suppliers in an orderly manner across time.

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