Purchase Orders in Procurement: A Key component for Efficiency and Control

In the domain of procurement, certain documents are extremely essential, one of which is a purchase order. Purchase Order, often abbreviated as PO, serves as the major pillar of all the activities associated with procurement in individual organizations. Moreover, it is a key component that maintains a seamless course of goods and services and compliance with financial controls. It sets up mandatory agreements between buyers and suppliers clearly and directly.

The part of the procurement cycle that deals with the acquisition and payment of goods and services is called purchasing. Purchasing is concerned with the direct procurement of goods and services. It starts with the creation of the purchase order (PO) and proceeds progressively through the stages of billing & accounting, fulfilling, transferring, and paying. The primary goals of purchasing, which is a tactical and specialized function that operates within individual corporate organizations, are cost minimization and efficient purchase.

What is a Purchase Order?

Purchase orders (POs) are the basic documents that govern and control purchasing transactions between a buyer and supplier. Moreover, procurement orders are not merely tools or administrative tasks that support procurement; they play a crucial role in enabling and ensuring the smooth operation of the entire process. Purchase orders are essential when it comes to financial management.

It serves as a legal document form that is sent by a buyer to a vendor with the intent of controlling as well as tracking the purchasing process. A purchase order carries all the information about the products, quantities (type/ quantity of goods/services, etc), costs, delivery timelines, and terms of credit for a purchase from the supplier. Once a vendor accepts a purchase order, it becomes a legally enforceable agreement.

Purchase orders constitute several key components according to a set format that are as follows:

1. PO Number: it is a type of unique identifier for the purchase order that is essential for keeping a record of the order and track it.
2. Information about the Buyer and Supplier: It comprises recent contact details, emails, and addresses of both the buyer and supplier.
3. Order Date: It is the date on which the purchase order is discharged or issued.
4. Description of Goods/Services: It constitutes a detailed information about the services or products issued or being ordered, along with the details regarding part numbers, provisions, and quantities.
5. Total Cost: This comprises the information about the unit price of each item ordered and the overall total cost of the order.
6. Delivery Instructions: All the information from the location, quantity of the order issued, delivery method to the expected delivery date.
7. Payment Terms: The agreed conditions set by the seller for the buyer along with the due dates and any applicable discounts or penalties.

Importance of Purchase Order

Purchase orders are important as they provide control over various departments in an organization and promote financial discipline. Purchase orders play a critical role in the procurement process. Below are some of the main reasons that support the statement:

1. Legal Protection:

• Legal protection is an important aspect of a purchase order. A purchase order becomes a legally binding contract once the supplier accepts it. This legal document ensures the safety of both the buyer and the vendor. The acceptance of the purchase order by the supplier states that the supplier is obligated to deliver the goods or services as specified, and the buyer is committed to paying the agreed price under the terms and conditions mentioned in the PO.

2. Budget Control and Financial Planning:

• Purchase orders are extremely important in managing finances and expenses related to purchases. Purchase order helps in financial planning, as it is used by businesses to predict expenses accurately, thereby supporting budget control.

3. Efficient Procurement Process:

• Purchase orders ensure that the procurement functions within an organization are executed smoothly. Purchase order comprises all the information about the product or services requested by the buyer, including price, quantity, location, delivery methods, etc., which keeps things clear and avoids any miscommunication. Details mentioned in a purchase order are kept as a record for increasing the effectiveness of procurement functions.

4. Inventory Management:

• With the help of purchase orders, organizations get an idea of the quantity of products or services needed, which further contributes to maintaining optimal inventory levels and saving money. It also helps businesses to avoid any shortage of stocks.

5. Audit and Compliance:

• Purchase orders are vital for both internal and external audits, as they contain the record of all the expenses related to procurement. It ensures that procurement functions within an organization align with company norms.

6. Supplier Relationship Management:

• Purchase order also helps in achieving an effective supply chain and long-term companionship between the buyer and the vendor. It has all the important information documented as proof to avoid any disagreements or miscommunications that help in establishing trust.

A Step by Step overview of Purchase Order Process

The process of purchase order involves following steps:

1. Purchase Requisition: A purchase requisition is a formal request by the buyer who wants to purchase goods or services for the business. It is an initial internal document that initiates the process of purchase order. These purchases can be for office supplies, manufacturing inputs, or inventory.
2. Creation of Purchase Order: A purchase order is created after the approval of the purchase requisition. The purchase order document constitutes essential information about the purchase, quantity of goods and services ordered, total price, location, delivery instructions, etc.
3. Approval of Purchase Order: The next step after the creation of the purchase order involves its approval by the relevant people in charge within the organization. This approval is based on the agreed budget and company policies.
4. Granting Issuance of Purchase Order: Once the purchase order is created and approved, it is issued to the vendor. After agreeing to the terms and conditions, the supplier reviews the purchase order and commits to delivering the goods or services as requested or specified by the buyer.
5. Order Fulfillment: The vendor manages the order, which involves delivering the goods or services to the buyer's specified location by the estimated or agreed-upon date. The supplier must abide by all the specifications that are specified in the purchase order and execute the process accordingly.
6. Receipt and Inspection: After receiving the desired products or services, the buyer examines them to make sure they meet the specified criteria as mentioned in the purchase order. If the products or services received are as expected, then the buyer provides an acknowledgment receipt of the goods or services.
7. Invoice Matching and Payment: Based on the purchase order, the supplier generates an invoice. Further, the invoice generated is matched with the purchase order and the receipt of goods or services, which, after verification, proceeds with the payment according to purchase order specifications.
8. Record Keeping: As the final step, all the relevant documents (invoices, receipts, etc.), along with the completed purchase order are stored for keeping a record of the purchase and audit purposes. These documents are often kept for financial reporting.

Purchase orders provides businesses with a formal binding contract that can be referred back to as evidence of what was agreed between the buyer and supplier, which could come in handy if there is ever an issue or non-compliance. Moreover, purchase orders also play a crucial role in reducing risks and ensuring that relevant parties are sticking to the deal because if some misunderstanding occurs and one of the parties or the other disagrees with certain specifications about the agreement's terms — then purchase orders could clarify it for you.

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Our main objective is to empower companies to achieve procurement supremacy and increase the efficiency of their purchase order processes and overall procurement procedures. To find out how we can support your business to thrive in the fast-paced global economy, get in touch with us right now. Let us develop your purchasing plan together!

Author

Ayushi Raj (Associate Business Analyst in Procurement Resource)