Are purchase orders obsolete, or do they have some benefit over credit cards?

Question

I just learned of Purchase Orders, which sound like they are used for purchasing expensive things in B2B. For example, if you wanted to purchase a large factory machine for several $k:

I have only ever really used a credit card (and checks and such). Even if you were to pay for rent or a mortgage (paying for on the order of $100k+) house or something, you just create a contract and then do monthly payments with a check or something similar like a direct deposit or transfer or something. So you don't need "Purchase Orders" or anything like that here. Which makes it seem like Purchase Orders might be either a legacy thing, or if not, maybe there is some other need or benefit to using them (in which case I would like to know why you need to use them over a check / credit card).

So I'm wondering if Purchase Orders are legacy, and that they could be replaced with todays technology just with a credit card or check. Or if they are not legacy, and in fact they are very necessary, in which case I am wondering why they are necessary (and why you can't accomplish with a credit card / check what you can with a Purchase Order).

Answer 1

A purchase order is just a document essentially equivalent to a seller facing invoice; where an invoice is the buyer facing piece of transaction documentation.

When you fill your cart at Amazon, your submitted cart is your purchase order. Amazon processes your purchase order and issues you an invoice.

Payment method is separate from this documentation but is typically indicated in the documents.

A purchase order is just paperwork, it's the basis of the contract between buyer and seller, an accepted and, likely, signed purchase order is generally used as a contract or part of a contract. In B2B transactions, terms (item, item quantity, delivery, timing, payment method) are negotiated, you can't negotiate with Amazon; you just fill your cart and submit your purchase order.

This is a typical B2B buying process*:

1. A buyer will send out an RFP (Request for Proposal) or RFQ (Request for Quote) to multiple vendors.
   • If this is an established vendor relationship these terms are already enshrined in some sort of contract you can just skip to number 4 and submit the purchase order.
2. Many vendors will respond and indicate various pricing differences based on payment method
3. The buyer may then begin to negotiate terms
   • Ex1: I'll pay in cash this week but the discount needs to be 7% not your indicated 2%.
   • Ex2: I'll pay you the first $1,000 now via corporate Amex and the remainder as COD (Cash on Delivery)
   • Ex3: Your rush fee of $1,000 to deliver in 15 days is too high, I'll pay $800 rush fee for delivery in 20 days, but if delivery occurs after 20 days I take a 20% discount.
4. Terms are accepted by both parties; buyer submits the purchase order
   • This is now a contract between buyer and seller, the purchase order may include various breach or underperformance terms (a cancellation fee, or late delivery discount, etc).
     • Seller will now incur costs to begin work in reliance on the purchase order.
     • Buyer will begin other preparations in reliance of delivery.
5. Vendor begins work in consideration of the purchase order
   • Vendor has likely not been paid in full at this point
6. Vendor delivers including an invoice based on the terms of the purchase order
   • Payment is now due to the vendor

The purchase order can include all sorts of terms. It might require the buyer to buy a specified minimum number of units over the next year. Sprint did this with Apple a number of years ago, if I remember correctly, in order to sell the iPhone at all Sprint agreed to buy $2B worth of iPhones over a 24 month period. So Apple was in possession of a purchase order from Sprint.

Separately it's typical for B2B to have wildly different payment terms than consumer transactions. You may google '10 net 30' this is typical B2B jargon that would indicate a cash discount if paid within 10 days of invoice. 1%/10 net 30, means buyer can take a 1% discount if the invoice is paid in 10 days, otherwise the invoice is due as is in 30 days and after 30 days interest likely begins to accrue.

I suspect your point of confusion comes from reading about accounting, and the fact that the purchase order triggers some accounting entries based on it's value. In business accounting there's the concept of payables and receivables. A receivable is an asset of the company, I have a contract that says Joe will pay me $1,000 so I have a $1,000 asset to put on my balance sheet; and remind me to collect from Joe. A payable is the inverse, it's a liability saying I owe $1,000. Once this offer is accepted and there's a contract, the seller can book an asset called receivable for $X and the buyer books a liability called payable for $X because the PO has a value of $X. Once the seller receives some or all of the payment it will debit the receivable and credit the asset checking (or something similar) and now it's revenue. The purchase order is not payment, but it does have value from an accounting perspective.

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* This is obviously just an example and not a intended to be a definitive outline of B2B buying, please don't comment about potential procedural nuance.

Answer 2

They're completely different things. Purchase orders are an ordering method. Credit cards are a payment method.

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Purchase orders are a process by which a company tells a vendor what they want to buy. This allows the order and its billing to be tracked. PO 45161 is for Jane in prototyping to be used on the Falcon project. The company buyer orders it. Accounting knows whose budget to ding. Shipping knows where to route the box with PO 45161 on it.

Jane goes through the packing list (shipper) listing each item in the box, and ticks off everything that arrived in good order, and sends that to Accounting.

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Separate from that, the item is paid for. Normally the vendor sends an Invoice - then accounting syncs that with the PO (did we order it) and shipper (did we receive it) and pays within 10-25 days.

However if the vendor isn't offering credit terms, accounting/buyer may just whip out the Mastercard and pay for it at order time. The PO is still required.

Answer 3

A purchase order can also be used to delegate the responsibility of collecting some item to someone without the authority to commit the company to buying it.

Consider a builder and a hardware store. The builder buys a lot of hardware, so the store offers him volume discounts and deferred payments to keep his business. But, the store does not want to give that discount on the personal purchases of all the builder's employees, and the builder does not want his employees (or anyone else) putting their purchases on his account. So the store and the builder agree that for anything to be put on the account, it needs to be accompanied by a purchase order, specifying what's being bought, and agreeing to pay for it.

Answer 4

A purchase order forms part of the contract. It tends to state delivery and costs for the seller to accept or decline the order. And a certain percentage of transactions will have disputes and this is the main evidence.

However it's main purpose are accounting controls. Everything is bought on a purchase order, in the case of credit cards it may only be an internal document.

I was a purchasing officer for years. I was authorised to buy stuff to sell. I am NOT authorised to buy a replacement photocopier.

The people that sell the stuff have to get me to buy it. They can't spend the company's money.

It's how companies control their cash.

Answer 5

You may not realize it, but if you have ever employed (say) a builder, you have almost certainly given him a purchase order. Typically you request several quotes, haggle with one or more builders over the price and details, maybe get a fully revised quote, and order against it. This might be verbal, but the builder will probably want a signature on paper -- the purchase order.

A legally binding contract is now in effect. You maybe won't pay until the work is complete. Or you'll pay in stages, as agreed, with a deposit up front.

You may settle by credit card, if the builder takes cards. Or bank transfer, cheque, even cash (with receipt!)

A verbal purchase order is common, for smaller services like (say) a boiler repair. They'll tell you terms like a call-out fee and hourly rate. You agree a date and time. When you agree on the phone, it's all been recorded. That recording is a purchase order and establishes a contract. They turn up and fix your boiler, then you pay.