Purchase Order (PO)

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Purchase Order?

A purchase order (PO) is legal document buyers send sellers to order goods. This document contains prices, quantity, payment terms, and delivery schedule information. It also includes the buyer’s details. Buyers use purchase-orders to compare goods delivered and goods ordered.

It is simply an organized way of ordering goods. If the vendor accepts a purchase order, it serves as a contract for both parties. It reduces risks for both parties, as non-fulfillment of the terms can result in legal consequences.

Key Takeaways

  • A purchase order (PO) is a formal document that buyers issue vendors listing the required items, quantity, preferred purchase price, and expected delivery date. It also establishes payment terms and the desired credit period.
  • It is the vendor’s call to accept or reject a purchase order. However, once accepted, it becomes a purchase contract between the buyer and the seller.
  • Usually, buyers draft four different types of purchase orders; standard, planned, blanket, and contract orders.

How do Purchase Orders Work?

A purchase order is simply a well-crafted list of items a buyer wants to procure from a vendor. It becomes legally binding when accepted by the supplier. Earlier, large firms used to prepare purchase orders on paper, but now digital purchase orders have replaced them. Also, small firms use purchase orders to track and manage inventories efficiently.

Now let us walk you through the process:

  1. First, the buyer lists the required items.
  2. Next, the buyer decides on which vendor to buy from. This is specific to each product.
  3. Then, the buyer prepares purchase orders and sends them to the vendor. This could be on paper or sent electronically. They make use of templates for convenience.
  4. The vendor goes through the PO details, and if it is workable, a confirmation is sent to the buyer.
  5. The confirmation indicates a purchase contract between both parties.
  6. At this stage, the seller prepares the order, assigning the required workforce.
  7. Product delivery is the next step. For easy identification and tracking, the PO number is mentioned on the packing slipsPacking SlipsA packing slip template is a physical document that mentions the items that are ready to be shipped to the customer.read more.
  8. At the time of delivery, the seller attaches the invoice with the products. It contains the PO number for crosschecking purposes. 
  9. Finally, the buyer makes the payment according to the agreed terms and conditions.

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Purchase Order Format

Following is a simple format for a purchase order.

Purchase-Order Format

You can download it from this page – Purchase Order TemplatePurchase Order TemplateA Purchase Order is a formal written intent of the procurement of goods by the buyer of the product to the seller. Once issued by the buyer, the same has to be accepted by the seller, who then sends the buyer the final invoice.read more.

Generally, a purchase order consists of the following information:

PO NumberAn identification number for a particular order. It facilitates the tracking of PO status.  
PO DateThe date on which the purchase order is made.
Vendor-IdThe name, address, and contact details of the supplier.  
Buyer’s InformationThe name of the company placing the order, its address, and other contact details.  
Vendor’s InformationThe name, address, and contact details of the supplier.
Ship To DetailsThe place where the products need to be shipped.
Billing AddressIt can be the same as the delivery address.  
Shipping MethodThe medium of transit—roadways, railways, or airways.  
Payment TermsThe credit period, discounts, and other terms.
Date of DeliveryThe expected delivery date of the order.
Order DetailsProduct description—brand names, SKU number, model number, quantity, unit price, and the total amount (quantity multiplied by price).  
FreightThe delivery charges
TaxesIt includes the goods and service taxes, state sales tax, and other charges.
Total Order ValueThe aggregation of the total amount, freight, and taxes.

Purchase Order Example

Let us look at a hypothetical example and formulate a purchase order. ZYX Ltd., New York, required 100 office chairs with wheels at the agreed rate of $50 per chair. The firm sends a purchase order to the seller, LML Furnitures, New York. The purchase order example mentions the required quantity, price, and other terms as follows:

Purchase-Order Template

LML Furnitures ships the order on the delivery date and sends the invoice. The ZYX company verifies the procured products, matches the PO number, and makes a payment of $5,370. The payment is made within 30 days, keeping with the predetermined terms mentioned in the PO. 

Purchase Order Types

Following are the four types of purchase orders:

Purchase Order Types

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#1 – Standard PO

This kind of order though commonly used is primarily applicable to one-off purchases. A standard purchase order is suitable when the buyer is clear about the products’ price, quantity, payment terms, and delivery schedule.

For instance, an ironworks company creates a Standard PO for 60 cement sheets to construct a shade over its workshop. Each sheet costs $15. The cement sheet manufacturing company has to deliver the order within ten days.  

#2 – Planned PO

There are specific long-term contracts that require a steady supply of goods; however, the scheduled delivery date is unknown. Other order details like product types, price, payment term, and quantity are clearly defined.

For instance, a construction company gets a government contract for constructing a dam. The company creates a Planned PO for buying bricks from a particular vendor. However, the exact construction dates are still unknown. Therefore, the scheduled delivery date is also uncertain.

#3 – Blanket PO

As the name suggests, a Blanket Purchase-Order covers multiple orders within a single request. It is a strategy to avail bulk purchase discounts. But these POs may not state the original, discounted price or the time of purchase.  

For instance, a car manufacturing company issues a Blanket PO for the bulk purchase of tires. The tire vendor facilitates a substantial 17% discount.

#4 – Contract PO

In this type, the buyer and the vendor lay down the terms of the contract, agree upon it, and then sign it. It is a business transactionBusiness TransactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements.read more. Both the parties are legally bound to the terms. Such POs are common for purchase agreements to be executed in the future.

For instance, a multinational companyMultinational CompanyA multinational company (MNC) is defined as a business entity that operates in its country of origin and also has a branch abroad. The headquarter usually remains in one country, controlling and coordinating all the international branches. read more sends a Contract PO to an outsourcing firm— to acquire personnel for its soon to open branch.  

Benefits and Drawbacks

POs prevent duplication or forgery since they are formulated as legal documents. Both parties can track its status through the PO number. For any disputes, the parties can take legal action. Further, it helps vendors keep track of inventory. Finally, purchase orders facilitate budgetingBudgetingBudgeting is a method used by businesses to make precise projections of revenues and expenditure for a future specific period of time while taking into account various internal and external factors prevailing at that time.read more as vendorsVendorsA vendor refers to an individual or an entity that sells products and services to businesses or consumers. It receives payments in exchange for making items available to end-users. They constitute an integral part of the supply chain management for providing raw materials to manufacturers and finished goods to customers.read more can accurately determine pending orders. Thanks to POs, vendors know the exact quantity of upcoming orders even before they are placed. 

A PO simplifies the process of invoicing. It also speeds up sales dispatch; a PO makes reviewing orders efficient. It serves as the purchase evidence for the buyers during financial auditsFinancial AuditsFinancial audit is an independent examination of the financial statements of an entity irrespective of its size. It is done by auditors or audit firms who provide an opinion regarding the accurate and fair view of the facts & figures mentioned in the financial statements.read more. Buyers benefit, especially if the price of goods rises between the order time and delivery time.

Purchase orders have their own limitations. For example, preparing POs for every purchase leads to a lot of paperwork and effort. In addition, the rise in credit card usage for small orders eliminates the need for POs.

Purchase Order vs. Invoice

A purchase order is significantly different from an invoice, although both are used for business transactions. POs are prepared by the buyers, whereas the vendor sends an invoice to the buyer. The vendor issues an invoice to collect payments after delivering the goods.

Drafting POs is the initial step of entering into a business transaction. The invoice, on the other hand, is a final document. It is a sales receipt that lists the types of items, quantity, price, discounts, freight, and taxes. 

Frequently Asked Questions (FAQs)

How to write a purchase order?

One of the easiest ways to write a purchase order (PO) is to use a template. Buyers should clearly mention; required kinds of items, the required quantity of each product, the price they are willing to pay, the requested credit period, the payment terms, and the preferred delivery date.

What is the purpose of a purchase order?

The buyers draft POs to make a procurement offer to the supplier or vendor. It lists the required items, purchase quantity, price, payment conditions, and the expected delivery date.

Can a buyer or seller back out of a purchase agreement?

Usually, buyers can back out of POs at any point before the delivery of goods or services is made. This is unless such cancellation is not penalized under the predetermined terms.
A seller can reject a PO or bargain over it before acceptance. However, the cancellation of such a PO after its acceptance solely depends on the predetermined terms. The parties can amend the terms only upon mutual agreement.

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