Scrutinizing and managing all the paperwork that gets involved in starting a business can be perplexing. Purchase orders (POs) and invoices are among the necessary paperwork you have to deal with. While running a business, you might have stumbled across one or both of these documents.
Both these two are generally considered confusing financial terms, and both deal with the communication and of terms of payment agreements. In this post, we’ll explain what these documents are, the differences between them, and how they can serve your business.
What Is a Purchase Order?
A purchase order (PO) is a document created by a purchaser and sent to a vendor as an official confirmation of an order. Its primary function is to request a service or product without immediate payment. It includes an itemized list of the requested service or product that the vendor can approve or refuse based on the availability. From the seller’s viewpoint, a purchase order is a method to offer credit to purchasers without risk, since the purchaser is committed to making payment after the product or service is delivered. A purchase order is a legally binding contract between a vendor and a purchaser. In simple words, if you don’t have a purchase order, you don’t have an order from the customer.
A basic PO usually includes the following:
- Purchase order number
- Quantity purchased
- Date of the purchase
- List of Product or service being purchased
- Specific brand names, SKUs, or model numbers
- Price per unit
- Delivery date and location
- Buyer’s Billing address
- Payment terms and conditions
- Business name and address of both parties
The Usage of a Purchase Order
Beyond initiating an order, a PO also fulfills some additional functions including the documentation between purchaser and vendor, reference for invoices and inventory management. The details of these functions are as follow:
- The Documentation
Before order fulfillment, a PO validates that both the purchaser and vendor are in agreement. The purchase order demonstrates what’s ordered and at what time it should be delivered along with the total amount due after the delivery is completed.
- Reference for Invoices
Getting timely payment is important for a business and a purchase order number plays a significant role in that. After the delivery, the vendor usually sends an invoice to the purchaser detailing the purchase order number as a reference number. This reference number is used to match the invoice with the purchase order. It also guarantees that your invoice gets processed quickly with a lower risk of incorrect payments. It also serves as proof that products and services were ordered.
- Manage Inventory
If you’re managing purchase orders via software, then you can better track your inventory. A purchase order also assists in determining inventory, and when a restock is required.
What Is an Invoice?
An invoice is a document issued by the vendor to the buyer for the collection of the delivery made. The product or service details along with the total amount due are listed on an invoice.
A basic invoice usually has three main sections divided into invoice information, accounts receivable and accounts payable. The details of each section are as follows::
If you’re sending several invoices, the invoice Information includes the invoice date, invoice number and purchase order number.
The accounts receivable section provides information about the party that is receiving payment including business name, mailing address for payment and contact information.
The accounts payable includes the customer’s information including the name of the contact within the company, customer’s business name, and customer’s billing address.
The Itemized List of Products or Services includes invoice number, invoice date, payment terms, product or service description, agreed price or hourly rate, quantity or number of hours, shipping costs, applicable discounts, applicable taxes, and accepted modes of payment.
The Usage of a Purchase Order
Similar to a purchase order, an invoice also fulfill some additional functions including the payment collection, documentation between purchaser and vendor, and tax preparation. The details of these functions are as follow:
- Payment Collection
The main function of an invoice is to let the purchaser that it’s time to issue the payment. The lives of most business owners are hectic, and invoices serve as a reminder that the payment is due after the delivery.
- The Documentation
When joined with a PO, invoices also serve as documentation between the purchaser and vendor including the itemized list of products or service delivered and the total amount due. The vendor uses the invoice as a confirmation of transaction fulfillment.
- Tax Preparation
If you use invoicing software, this can make it easier to calculate business revenue for the tax year. The same information can also be helpful in tax preparation as well.
- The Function
- The function of a purchase order is to indicate that a buyer wants to buy something from a seller.
- After the purchase order is accepted and the vendor fulfills the delivery, the vendor can send an invoice to the buyer for payment collection.
- The Objective
- The objective of the PO is to purchase specific products or services from the seller.
- Alternatively, the objective of the invoice is to request payment from the buyer.
- The Timeline
- A purchase order is sent when the buyer wants to make a purchase.
- An invoice is sent when the order is fulfilled and payment is due from the customer.
- A purchase order is created first. An invoice is generated in response to a purchase order, but only after the deliverables were received.
- The Confirmation
- A purchase order is created to confirm a transaction based upon the terms agreed by both parties.
- An invoice is sent to confirm that the requested order is fulfilled and payment is due.
Purchase orders and invoices are two important documents for small businesses to initiate orders and complete them. Understanding how these documents function establishes that the buyer and seller both understand the transaction agreement.
Purchase orders are important from clarification and disagreement prevention perspective, whereas invoices are important from a legal perspective. Both these documents contribute to the success of your small business. Using online software to generate, document, and send your purchase orders and invoices will boost overall productivity. Investing in paid purchase orders or invoicing software can also assist in further optimizing your business performance.