Purchase orders (POs or PORs) often fulfil a key part of the procurement process, but they’re not used routinely by all organisations and there’s no obligation from an accounting perspective to have them – or is there?
For many small companies, with a limited number of services or goods being procured, the idea of introducing a purchase order to the process appears to be an additional, and often unnecessary, administrative task. Because there is no obligation to use them, in the same way as sequentially dated invoices are a prerequisite from an HMRC viewpoint and determine tax and tax point, most company owners will omit POs from the procurement process. But in certain sectors, where there are higher numbers of goods and services being ordered, a PO can be a useful tracking tool both in terms of receipt of goods and budgeting for expected spend.
Is a purchase order a key part of the accounting process?
There is no legal or statutory requirement to raise a purchase order as part of your accounting process. Goods and services can be procured without one and it is only the invoicing around the sale by the supplier that comes with any rules and regulations. In this respect, sales invoices generated by a company MUST be sequentially/consecutively numbered in a consistent format with no gaps or missing numbers.
Therefore, raising a purchase order is an option that you can decide to introduce or not. It is rare that a company would have a hybrid system with some goods/services requiring a PO and others not. Introducing purchase ordering to the procurement cycle tends to happen as a business grows or if there is a significant uptick in the number of requisitions a company makes. Decentralised businesses with disparate teams, divisions, departments, or branches/offices may also find purchase orders useful to keep an overall track of goods and more importantly devolved budgets.
Does a purchase order form part of an agreement to purchase?
Putting the question of accounting process to one side, purchase orders may have a bearing on the contract that exists between two organisations to supply goods or services. On its own, a purchase order may only signal an intent to procure, and not a imply any form of contract. Purchase orders therefore normally refer to terms and conditions of trade, and it is these two documents taken together that will form a commitment to buy/pay.
You may be familiar with organisations that require a name or purchase reference/number before they will accept an order. Equally, there are companies that won’t pay an invoice without valid PO number referenced or won’t accept goods unless they match a valid PO number. These will again be set out in the terms of trade but prove that the purchase order on its own is not the contract. This is an interesting point and companies will do well to not only look at their terms and conditions for their own procurement, but also their Ts and Cs for inbound sales.
As a for instance, where would the liability sit for an unfulfilled purchase order, or an order delivered without a PO? Is a supplier obligated to fulfil a purchase order and if you’ve made clear that an invoice needs a PO to be paid and goods are delivered without one, who’s in the right/wrong? You have the goods, should you pay?
Purchase orders for budgeting
The use of purchase orders and requisitioning as part of the budgeting process, can help an organisation get on top of their spend and better manage their cashflow. However, in isolation the introduction of purchase orders or budgeting alone is unlikely to resolve the full procure-to-pay cycle and the two need to work together to have any positive impact, especially if teams or departments are free to procure against pre-agreed budgets. Here’s a great, real-life example.
A charity, which is obligated to make best use of its funds, found that its procurement was something of a free for all. The new FD, keen to get on top of the situation introduced the idea of budgets. Department heads had to submit their budgets for approval each year and once approved by the board, they could only spend that allotted budget. Having introduced this process, the FD went about moving some of their cash reserves into bonds to try and generate some additional revenue. Just as the cash had been squirrelled away, he looks out of the window to see a hugely expensive new piece of plant being unloaded from a low loader, much to the satisfaction of the facilities manager. When the FD queried the purchase, the facilities manager pointed out it was in his budget, thinking that was all that it required. The supplier, needless to say, wanted paying. The facilities manager was correct, it did form part of his budget, but a purchase order would have given the finance team a heads up on the spend. The process effectively allowed for departments to spend their entire budget on day one of the financial year without any recourse to the finance team!