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Purchase Order Process — The Definitive Guide
A complete guide on purchase order process steps, the best optimization practices, and ways POs make a difference in your business operations and expenditures.
Independent research by Exact in 2018 found that British SMEs are losing about £3.7 billion due to poorly organized internal financial processes.
Meanwhile, a recent APQC study shows that manual ways to process the purchase order can cost a company over $500 per PO.
A purchase order process is one of the critical elements of the procurement cycle, and an efficient PO system can help speed up purchasing, improve spend control and budgeting.
That’s why it’s essential to understand what purchase order procedures and steps to follow and how to manage this process effectively.
Scroll down to find out:
- What are a purchase order and a PO process?
- PO process: exact steps briefly explained
- Best practices to control the PO process
- Benefits of using purchase orders
- Quick answers to related questions
What is a Purchase Order in Procurement?
Before we dive deeper into the purchase order process, let’s recall what a purchase order is.
A purchase order (or PO) is an official document sent by a buyer to a supplier that confirms the purchase and contains all the necessary information about it.
Once a supplier approves the purchase order, it becomes a legally binding document.
Therefore, it can protect both a buyer and a seller in case one of them refuses to fulfill their obligations.
We’ll talk more about why companies use POs later in this article, but now let’s look at what precisely a purchase order should contain.
Typically, a purchase order includes:
- Information about a buyer and a supplier (person of contact, email, address, phone number, and other contact information.)
- Order details: description, quantity, and price of the ordered items
- Payment information and payment terms
- Shipping method (if applicable)
- Order date and PO number
- Delivery date and address
- Invoice address
What Does a Purchase Order Look Like?
What is the Purchase Order Process?
The purchase order process refers to the purchase order cycle starting from PO creation and ending with PO closure. Usually, it also includes additional steps like quality checks and budget approval.
A purchase order process is a subset of a broader procurement process that comprises all the activities related to acquiring goods and services.
How Does the Purchase Order Process Work
PO process steps can be modified by companies depending on their size, corporate structure, spend category, etc., but the typical purchase order process involves the following steps:
- PO creation
- PO approval
- Sending of PO to supplier
- Binding contract
- Receipt of goods or services
- Three-way matching
- Purchase order closure
Step 1. PO Creation
In most cases, employees have to create a purchase requisition and get it approved by authorities before purchase order creation.
Then a procurement team (in larger organizations) or another responsible person, f.e., a financial or operations manager (in smaller companies), creates a purchase order based on the approved purchase requisition.
If the purchase is recurring, a PO can be created without a purchase requisition.
Step 2. PO Approval
After a PO is created, it is sent for approval to relevant authorities and modified if any requirements have changed.
A company’s approval workflow determines who has to approve the purchase order before sending it to a supplier.
Usually, several approvals are required, including one from a financial director, to ensure that a purchase complies with the budget.
Step 3. Sending PO to Supplier
When a PO is approved, a business has already chosen its suppliers and can issue them a purchase order. Often it is sent via email or online procurement platform.
Step 4. Binding Contract
Before approving a PO, a vendor can ask for modifications. Once a supplier confirms a purchase order issued by the buyer, it becomes a legally binding contract for these two parties.
Step 5. Receipt of Goods or Services
Next, an organization waits for a vendor to deliver ordered items and send an invoice.
After a procurement or warehouse manager receives the delivery, a responsible person audits the goods to ensure they meet the specifications laid out in the purchase order.
Step 6. Three-Way Matching
If the delivered items fulfill the requirements, a customer issues a goods received note (GRN) or another document that confirms delivery and performs a three-way matching — compares the goods receipt, the PO, and the received invoice.
A 3-way match is an essential step that helps avoid discrepancies between what the company ordered, received, and paid for.
Step 7. Purchase Order Closure & Record Keeping
If data on all documents matches, the confirmed invoice is forwarded to the finance department for payment.
Once a company pays for its purchase, it can close the purchase order and save it to records along with the invoice.
Once in a while, a company receives a customer order that’s too large to fulfill with available inventory. Replenishing inventory immediately would require a substantial cash injection, which isn’t always an option. That’s when business owners seek assistance with purchase order financing. Read more about PO financing in our article.
Purchase Order Process Flow
Let’s look closely at the purchase order process flow and sum up the exact steps a company must take to process a PO and buy necessary products.
So, how to process the PO?
- Create a purchase requisition;
- Create a purchase order;
- Issue a request for proposal (RFP);
- Evaluate supplier quotations and select a vendor;
- Negotiate contract terms with the chosen supplier;
- Send a PO to a supplier;
- Receive a confirmed PO;
- Receive the delivered order;
- Receive invoice and perform three-way matching;
- Make a payment;
- Record a purchase order;
- Close a PO.
How to Control the Purchase Order Process
When it comes to our daily routine, we’re really unlikely to go with a skiffle board instead of a washing machine, aren’t we? But this change of heart took time.
Many companies are taking their time to readjust as well, considering the spreadsheets and paper still widely used in purchase ordering processes.
But while manual processing may seem like a tried and true method, it has proven to be error-prone and time-consuming, not to mention the financial losses, associated with old-fashioned workflows.
As your company grows and requires increasingly more goods or services, the amount of purchase orders and invoices becomes too much to handle for your finance team members at a certain point.
This is where you should turn to e-procurement and automate your PO and procurement process in a centralized system.
Rebooting your internal processes may seem daunting at first, but if you switch to intuitive and straightforward purchase order software like Precoro, the full onboarding and implementation process won't take more than a couple of weeks.
Here are some benefits you can reap at once by taking this step towards PO automation:
- Reduce your paper trail
- Quickly trace POs to responsible people
- Create purchase requisitions in a few clicks
- Eliminate manual data entry and human error
- Set up a smooth approval process in the system
- Implement budget-driven expense restrictions and track spends easily
- Seamlessly create a PO from requisition or from scratch with a click of a button
- Manage your supplier base, inventory, store contact information and receive invoices in one place
- Perform the 3-way match automatically and sync documents with your ERP or accounting system
And much, much more.
What is the Significance of a Purchase Order in the Procurement Process?
Purchase orders are an essential part of an organization’s purchasing process and can help improve budget control. Here are the advantages of using POs:
- They help set up clear expectations from suppliers, enhance communication with vendors, and ensure that a company gets what it needs;
- As legally binding documents, when approved by suppliers, POs can protect both parties from unsatisfactory outcomes;
- They allow tracking purchase history, avoid duplicate purchases or unexpected invoices, and prevent uncontrolled spending;
- POs increase financial control and provide evidence for auditing transactions.
Frequently Asked Questions
The main difference is that a PO is created by a buyer, while an invoice is issued by a supplier. A buyer issues a PO to a vendor at the beginning of the purchasing process to request goods or services. On the contrary, a seller sends an invoice to a buyer almost at the end of the purchasing cycle to ask a buyer to pay for the delivered goods.
A buyer is responsible for creating a purchase order. It can either be a procurement department, a financial manager, or an operations manager within an organization.
It can vary among organizations. Most companies (in particular, larger ones) have a PO approval workflow that defines which employees are responsible for approving a PO. Usually, the approval is needed from a head of the department that requires the goods to be purchased and a financial director. In addition to approval within the organization, a PO also has to be confirmed by a supplier.
A company needs a defined PO process to streamline its purchasing cycle. In addition, purchase orders allow to indicate exact expectations of a supplier, act as legal documents, increase budget control, and help with financial auditing.
If a supplier has confirmed the PO, yes, it is a legally binding contract.
PO reconciliation process (also known as PO recon) involves reconciling POs with invoices as a part of three-way matching.
To Sum Up
Purchase orders or POs are documents that a buyer sends to a supplier when requesting an order. Once confirmed by the vendor, they become legally binding contracts.
The PO should include a description of requested goods or services, the quantity of items, and the agreed pricing and payment terms.
A purchase order process is a subset of the broader procurement process. It includes the following steps: PO creation with an assigned PO number, approval, dispatch to a supplier, receipt of delivery, 3-way match, payment, and PO closure.
Depending on your company size, industry, and requirements, the PO process steps may vary.
Among the best practices of purchase order processes are establishing a company-wide purchase order process flow and automate it using procurement software.
Automation ensures transparency, proper approval routing, inventory and budget control, saves your employees' time, paperwork and eliminates errors.
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