What is a Purchase Order? How is it Different than a Contract?
When you’re running a business, it’s important to know the difference between a purchase order and a contract. Many people think that they are the same thing, but they are actually two very different documents.
A purchase order is an agreement between a buyer and a seller to buy goods or services at a specific price. A contract, on the other hand, is an agreement between two or more parties that sets out the terms and conditions of their arrangement.
In this article, we’ll dig into what purchase orders and contracts are, what the differences are between them, and how to know which one you need.
Differentiating between a purchase order from a contract isn’t always easy, as the two documents have too many similarities.
What’s a Purchase Order?
The need for a purchase order all starts with someone in the company deciding that they need something. They then send a purchase requisition to the purchasing department of the company, basically requesting for that item or service to be purchased.
When the purchasing department approves the request, the purchase requisition then becomes a purchase order. This will then be sent to the vendor, and thus by necessity, it needs to include various information. It should have the description (what you’re buying), quantities (how many), prices, and maybe even discounts.
The purchase should have a PO number, the date of issue, and the signature of the purchasing manager who authorized the sale. In addition, this might contain extra details, including payment terms and shipment or delivery dates.
There is also such a thing as a blanket purchase order (which can also be called a blanket purchase agreement, or call-off order). This is the type of purchase order needed when the deal involves multiple delivery dates over a period of time.
Whether it’s a simple purchase order or a blanket purchase order, it’s still only a commercial document that’s basically saying: Our company needs this item. Can you, the vendor, give us what we need, as specified in the purchase order?
If the vendor accepts the purchase order, then the vendor is saying: Yes, we will get you what you need, at the price listed on the purchase order. And by accepting, it becomes a contract.
The Key Differences
A contract is an agreement that can also list down a similar set of details. So yes, there are similarities between a purchase order and a particular type of contract.
But you can focus on the following factors to note the differences:
This is perhaps the most obvious difference between the two documents. It’s because a purchase order is only about a single business transaction. The details specified on the purchase order pertain only to that particular transaction.
But contracts often represent a longer time frame, and there may be renewal options as well. And the contract can specify the terms used for all the purchase orders from the vendor within the valid timeframe of the contract.
This means that you might have a contract with a vendor for a whole year, and within that time frame, there are several transactions involved with that vendor. Your company can then use the purchase orders to verify that the terms of the transaction follow the terms specified in the contract.
A contract, by its very nature, is legally binding. As soon as both parties sign the contract, it’s a legal document.
But a purchase order is essentially a commercial document. It only becomes legally binding once the vendor accepts the purchase order. And if the vendor doesn’t accept or approve the purchase order, then that purchase order doesn’t have any value. It’s basically meaningless, as it’s just a rejected request.
Does the business transaction come with some risk involved? If that’s the case, then it’s generally better to have a contract. This is because the contract is by definition a legal document, and it has more legal value than a mere purchase order.
The contract can mitigate the risk exposure because it can clearly delineate the responsibilities and rights of each signatory to the contract. And the contract can also specify performance standards.
But it is still useful to use the purchase orders in conjunction with the contract. That’s because the purchase orders usually specify the quantity of the goods, and the delivery times as well.
Terms and Conditions
Both a contract and a purchase order usually have terms and conditions listed in them. But in contracts, these terms and conditions are generally more specific. When it’s crucial that both parties need to be on the same page for various factors, then the contract works better. It can lay out more details regarding factors such as the scope of the work, the performance standards, and change management requests. The details in the contract may include terms that may not be stated in the purchase order at all.
Typically, a business uses a purchase order to order and purchase something, which is usually a product or an item. But when a business can go with a contract when the business requires a service.
A business might also use a simple purchase order for a single, short-term purchase. But the contract works better in establishing a long-term buying relationship.
The Bottom Line
So, when should you use a purchase order, and when do you need a contract?
- Do you need an item once? Use a purchase order.
- Do you need to keep buying an item more than once? You need a contract.
- Do you need a service? You need a contract.
- Is there a risk regarding legal issues concerning the transaction? You need a contract.
Keep in mind that you always need a purchase order for each transaction. But unless it’s a one-time deal for some items, you need that contract. It’s always good to spell things out clearly in a contract.