Purchase orders: How to know when and which type to use

Businesses can effectively manage company finances by using purchase orders, also referred to as POs. POs help businesses stay within their budgets for planned purchases. Using POs also allows businesses to easily track purchases.

Businesses rely on their vendors to get the supplies they need when they need it. A purchase order helps clearly communicate supply requirements and purchase terms. This helps eliminate errors and delays.

This article explains four common types of purchase orders, provides examples of each, and describes their best use.

The purpose of purchase orders

Purchase orders are a vital part of the procurement process. POs specify pertinent information including what you’re buying, how much you’re buying, and other relevant information – mode of delivery, payment method, and terms of service.

When your vendor formally accepts the purchase order, it turns into a legally binding agreement between you and the vendor. Therefore, it is best to be detailed to ensure that the terms and conditions related to products, pricing, and delivery are fulfilled are accurate. In the event, the PO is not fulfilled in compliance with the terms, you can file legal action against the offending party – just understand both the business or the vendor can be the offending party!

The following components should be included in your purchase order:

• An internal PO number linking the transaction to other documents and records in the system,
• Description of the type of goods being purchased,
• Quality and quantity specifications,
• Detailed vendor information,
• Mutually agreed upon pricing information,/li>
• Terms and conditions associated with the delivery, and
• Payment-related terms and conditions.

Purchase orders can vary, just keep in mind that more detail is better. Purchase orders can also be used to audit overall spending and the financial health of your business.

Before jumping into the types of purchase orders, here are some basic terms you should be familiar with:

• Legally binding. Once approved, all purchase orders become legally binding, meaning both parties are responsible for adhering to the terms and conditions or legal ramifications may apply.
• Accounting distribution. This refers to the monetary amount issued to the vendor account after placing the order.
• Encumbrance. A burden or impediment. This is the money set aside to fulfill your obligation under the purchase order. The PO encumbered a certain amount of money to pay for the goods listed.
• Release. A written notice from the buyer authorizing the supplier to process the order.

Types of purchase orders

Below are the four basic types of purchase orders. Once you understand the purpose of each, you’re better able to select which will work for you.

1. Standard purchase order

Standard purchase orders (SPOs) are the simplest and most common type of PO used. Businesses typically use SPOs for infrequent, irregular, one-time purchases, which they do not expect to incur regularly.

Because SPOs are used for one-time or infrequent purchases, the approval process can take longer. SPOs require more detail. The vendor is expected to fulfill the one-time order without any assurance of future orders.

SPOs includes these components:

• List of items to be purchased,
• Quality and quantity of each,
• Individual item price and extended price,
• Delivery date for the items ordered,
• Delivery location for the items, and
• Terms and conditions associated with the order.

Here are a few examples of when to use an SPO:

• Replace tables and chairs for those that are broken or worn out at a restaurant.
• Purchase a 3D printer for an architect’s office.

In some cases, businesses may elect to expense basic items rather than initiating the purchase order process.

2. Planned purchase order

A planned purchase order (PPO) is used to replace or regularly restock inventory. PPOs include everything in an SPO except delivery details, i.e., the date and location of delivery. Because items are often restocked at irregular periods, a schedule release is used to confirm delivery and details of delivery. The PPO guarantees the products will be available and the release informs the vendor the buyer is ready to receive those items.

Also included in the PPO is purchase frequency and whether items are purchased batches, sets, or bundles.

PPOs include:

• List of items to be purchased,
• Quality, quantity, and sets (batches, sets, bundles),
• Price of each,
• Purchase frequency, and
• Terms and conditions associated with the order.

These items are not included on PPOs:

• Confirmed delivery location of the items ordered.
• Confirmed delivery date of the items ordered.

There may be instances where the PPO can include some tentative schedules. However, such schedules must always be confirmed by a release before the order is confirmed for delivery.

Here’s an example of how to effectively use a PPO: A restaurant that uses 20,000 disposable placemats annually can use a PPO to secure purchase of those placemats. The PPO will provide details of the order as well as a tentative release schedule. A release is used when the placemats are needed that details delivery information.

3. Blanket purchase order

Use a blanket purchase order (BPO) to order specific items of unknown quantity or timeframe. BPOs are also referred to as standing purchase orders and can prove helpful to lock down pricing terms with the vendor before making any purchase. When it’s difficult to accurately predict product forecasting, blanket purchase orders can be useful.The difference between a BPO and a PPO is that a PPO has an undefined delivery schedule. A BPO has both an undefined delivery schedule and an unidentified quantity.

Blanket purchase orders can be beneficial for buyers, but they can pose fulfillment challenges for vendors. Because quantity is unknown, vendors often set a maximum number of units available per BPO. Vendors can also limit ordering timeframes and, in some cases, provide discounts for meeting quantity thresholds within the lifespan of the BPO.

Releases created against BPOs are called blanket releases. Just like PPO, a release against the BPOs is required before delivery takes place.

Here is what is typically included on BPO:

• List of items to be purchased.
• Terms and conditions associated with the order.

A BPO does not include:

• Confirmed delivery location of the ordered items,
• Confirmed delivery date of the ordered items, and
• Confirmed quantity of the items.

However, the vendor and the buyer can mutually negotiate and confirm pricing details for each item, along with any quantity discounts.

Here’s an example of when to use a BPO: In the previous restaurant scenario, the restaurant estimated an annual need for 20,000 disposable placemats. However, in the case of a new restaurant, it can be tricky to estimate how many placemats will be needed. In this case, the restaurant can place a blanket purchase order for disposable placements to secure a better price even through recurring purchases even though the quantity is unknown.

4. Contract purchase order

Of all the purchase order types, the contract purchase order (CPO) is the most complex. It also contains the fewest details. The purpose of the CPO is to establish a relationship between the business and its vendors – it establishes the contract between the two.

CPOs take the place of drafting individual purchase orders. They create long-term agreements with specification about terms and conditions of future purchases without specifying any product or delivery information.

CPOs are beneficial  when you’re unsure of what, when, and how much to order. Contract purchase orders do not come with an expiry date and can be used as a baseline to create a framework for future purchase orders. As such, CPOs contain:

• Negotiated terms and conditions that act as a foundation for creating other purchase orders in the future.

The CPO does not include:

• Details about items to be purchased,
• Quality and quantity of items to be purchased,
• Price of items to be purchased,
• Delivery dates for ordered items to be purchased, and
• Delivery location of items to be ordered.

A contract purchase order is flexible, and generally benefits both parties. While there’s a wide range of possibilities to serve as examples of a CPO, here’s just one: A CPO can establish an agreement between a business and a vendor where the business hosts several events throughout the year. During the events, the business purchases items from the vendor at a 20% discount in exchange for listing the vendor as an official sponsor.

Wrapping up

Knowing which type of purchase order to use largely depends on your business, how long you’ve been in business, and being able to accurately forecast inventory and business needs. Often businesses will use more than one type of purchase order throughout the lifecycle of the business.

Use this easy table to compare the different purchase order types to identify which will work best for you and the needs of your business.

Technology plays an important role in the inventory process, including automating the purchase order process. Implementing an order management software allows you to streamline your purchase orders.

You can configure reordering points whereby a purchase order would be automatically placed to your vendor whenever your stock falls below a predetermined threshold. That way, you do not have to worry about running out of inventory.

Schedule a free call with Cin7 experts to discover how we can help you streamline your purchase orders.