Purchase order vs invoices: What’s the difference?
Purchase orders and invoices are documents that contain details of your financial business activity. More specifically, they indicate whether your transactions are purchases or sales.
While they share some similarities, such as order details, price, vendor information, shipping details, and general information on a transaction, purchase orders and invoices are intrinsically different documents.
A purchase order (PO) is issued by the buyer to the seller and outlines the client’s expectations in terms of the product or service they plan to buy as well as the quantity. An invoice, on the other hand, is issued by the seller to the buyer after the terms of a purchase order have been carried out. It includes the financial terms that were laid out in the PO as well as options for payment.
Understanding the purpose and nuances of these two important documents is critical to ensure you remain compliant and organised when it comes to your business’s financial endeavours. They also allow you to maintain a healthy cash flow, something critical to ensuring your business is in a good place to handle any financial emergencies.
In this article, we’ll help you understand what purchase orders and invoices are, how they differ, and why they’re important to your business.
Table of contents
- What is a purchase order?
- Why is a purchase order important?
- What is a PO number?
- What is an invoice?
- Why are invoices important?
- Differences between purchase orders and invoices
- Similarities between purchase orders and invoices
- Why do companies need both documents?
- Issuing purchase orders and invoices
- Wrapping Up
What is a purchase order?
A purchase order (PO) is a document a buyer sends to a seller after ordering goods or services. POs outline what the order should contain, the date of delivery and price.
Some POs also include prerequisites that both the buyer and seller have agreed to before the purchase. These could be anything from receiving a certain quantity of good or items by airfreight to using an alternative payment method for ordering.
After the seller accepts the purchase order agreement, the document becomes a legally binding contract.
Buyers can also use standing purchase orders to facilitate recurring purchases. A standing PO allows them to order the same items or services many times over or within a certain time frame with the same PO number.
Alternatively, the ordering party can draw up a blanket purchase order to get multiple deliveries for a set price, over a set period. Blanket POs are typically used in B2B purchases and may include discounts or other incentives.
A basic PO usually includes the following information:
- Date of purchase
- PO number
- Order description
- Unit price
- Delivery date
- Buyer name and address of the buyer (shipping address)
- Vendor name and address of the seller (billing address)
- Terms and conditions
- Signature of the issuer
Some business owners confuse purchase orders with purchase requisitions. However, there is a notable difference between the two documents.
Employees in large companies use purchase requisitions to place orders with the purchasing department. The purchasing department then sources the required goods from an outside vendor or merchant. This means that the order is processed internally by those in charge of procurement.
Requisition orders are common in larger companies with various departments but rarely used in small business.
Why is a purchase order important?
Whether you’re a small business or a large company, there are many reasons why you would want to use POs for order placement. A purchase order allows you to:
- Set clear expectations. A purchase order allows you to clarify your requirements to your vendors. This ensures that expectations are clear from day one.
- Avoid duplicate requests. When the order request volume increases, POs help to keep track of who ordered what, from whom and when. Without a purchase order, you can end up making duplicate requests and causing a loss to your business.
- Prevent cost overruns. With a PO on hand, you can check the pricing agreement you had with a specific supplier. If that supplier decides to increase the price, you can use the purchase order to clarify the initial cost.
- Detect performance issues. An analysis of your POs can give you clues about which orders are contributing towards your growth and which ones are increasing costs without offering any value. With such insights, you’re more likely to be strategic with your purchases.
- Manage inventory effectively. If you’re using software to manage your POs, then you can better manage your inventory. Companies usually don’t have clear inventory visibility which causes problems like inventory stockouts. A purchase order system will help you determine how much stock you should keep and when it’s time to replenish, effectively helping you to streamline your operation and enhance your inventory management.
- Improve budgeting. To issue accurate POs for a large project, you’ll need to calculate order quantities and costs before the project commences. This should give you a better idea of how to budget for such projects.
What is a purchase order (PO) number?
A purchase order (PO) number is a unique reference number assigned to a purchase order. It helps ensure the seller ships the same goods that the buyer is expecting to receive.
Additionally, the purchase order number makes it easier to match invoices to purchase orders. Mentioning the number on invoices helps the seller charge the right amount for the goods. The buyer can also match the reference number on the invoice to their PO number to ensure they’re paying for the right order.
What is an invoice?
An invoice is a document created by the seller or supplier of goods as a way to keep track of and solicit for payments.
Sellers send out invoices after the terms of a purchase order have been met, whether that be through a finished physical product or a completed service.
Say, for example, you are a cereal supplier and you get a PO for two hundred additional boxes of cereal from a local grocery store. When you send them the goods, you will include an invoice that details the number of products, the price per product and the payment terms.
Regardless of whether your company supplies goods, services, or a mixture of both, a basic invoice usually includes the following information:
- Invoice date
- Invoice number
- PO number
- Item or service descriptions
- Agreed unit price
- Terms of payment
- Discounts (if applicable)
- Taxes (if applicable)
- Total amount due
- Invoice due date
- Acceptable methods of payment
- Business name and contact of the seller and buyer
- Signature of the seller
Invoices provide a way for you to keep track of your revenue, whether it be through cash basis accounting or accrual basis accounting.
Under cash basis accounting, when cash is received (e.g. an invoice is paid), then revenue is recognised. In accrual basis accounting, your sales represent revenue that has been earned. Revenue is then listed on the top of the income statement.
Both methods of accounting have their positives and negatives, but the invoice plays a vital role in how your company determines when you record expenses and revenue.
Top Tip: Understanding the basics of small business accounting will help you to make more informed financial decisions for your business. Specifically, it’s helpful to understand these two accounting methods, the three main financial statements, how to use accounting software to save time and the difference between an accountant and a bookkeeper. To learn more, read our complete guide to accounting for startups.
Why are invoices important?
At its most basic, an invoice is a document that gets you paid, but there are other important aspects to it. For instance, invoices allow you to:
Create a paper trail
One of the invoice’s key purposes is to create a paper trail between the buyer and the seller. Sending, receiving and settling invoices proves that both parties are communicating, while an invoice’s itemised nature keeps your business dealings transparent.
Help everyone stay on track
As a small business owner, you’re busy, your clients are busy, and your suppliers are busy. Invoices are a necessary way to keep everyone on track with payments. Each invoice shows the itemised goods or services for the most recent deliveries, but it also keeps a running total of account balances, should you or your customer be on a payment plan.
Simplify tax season
Who doesn’t want tax season to run a little more smoothly? Staying on top of your invoices protects you and your company, and it makes everything easier to audit and reconcile when the time comes.
Speed up payment and processing
You may be tempted to include the bare minimum in your invoices as a way to save time, but resist that urge. The more information you include, the fewer questions your clients will have, which can speed up the payment process.
Aid accounts receivable
Creating invoices is also essential because it is the record of your accounts receivable (all of the money due for goods or services that have been delivered but not yet paid for). Not only is this important for your balance sheet as an accounting document, it also helps outside investors understand how quickly your company is receiving the funds from outstanding invoices. By analysing the accounts receivable turnover ratio, investors can see how efficient your company is at collecting cash that is owed to it.
Reinforce brand identity
If you’re using an invoicing software or app, you should be able to personalise the content and appearance of your invoices. Personalisation helps to reinforce brand identity and also enhances the customer’s perception of your business. We’ll discuss invoicing software in more detail in a later section.
Differences between purchase orders and invoices
The key difference between the two documents is the objective or goal.
When you issue a purchase order, you are requesting for your suppliers to deliver the goods. When you issue an invoice, you are requesting customers to make payment. Hence, a PO’s goal is to ensure the fulfilment of orders while an invoice aims to collect payment for products or services sold.
Another difference is timing. A purchase order is usually sent at the beginning of the transaction to form a contract between parties. Invoices, on the other hand, are sent at the end of the transaction using the information from the purchase order to request payment.
Lastly, a purchase order contains different information than an invoice. POs include a detailed description of the order, the agreed price and the ETA for the delivery. In contrast, an invoice lists the terms of payment, applicable discounts and total amount due.
|Objective||Confirm the order||Request payment for the order|
|When it is sent||Upon placing an order||After the order is fulfilled|
|Details||Order description, agreed price, delivery time, etc.||Terms of payment, applicable discounts, total amount due, etc.|
Similarities between purchase orders and invoices
Purchase orders and invoices also share similarities. For instance, much of the time, both the PO and the invoice are referencing the same good or service. Plus, both documents list information regarding the buyer and the seller, including business names, contact information and mailing addresses.
Most significantly, both POs and invoices are legally binding agreements. That means that once either one is sent and received, that good or service needs to be prepared and paid for according to the previously determined agreement between parties.
Why do companies need both documents?
Simply put, your company may use both documents at one point or another because the nature of business requires you to order as well as provide.
Even if your company mostly provides goods or services (and therefore mostly send out invoices), there may come a time when you need to purchase something, and a purchase order will help you keep track of those expenses.
Issuing purchase orders and invoices
Purchase orders and invoices are not difficult to understand and use. However, manually creating tons of such documents is often time-consuming and error-prone, even if you are using an invoice template. Moreover, manual records have the potential to get disorganised, or worse, disappear, causing problems in disputes or at audit time.
Fortunately, digital PO and invoicing solutions let you do away with tedious processes like the paperwork-based document creation method. You won’t have to worry about things like paper, envelopes, ink, and stamps. You also won’t need to generate a photocopy of the document, which can get expensive if you’re issuing multiple POs and invoices every day. Using a digital solution is more cost-effective, secure and easy.
There are many invoicing software solutions available on the market, and while there is no one-size fits all product, there are general features that your invoicing software should include. These range from automated payment reminders to customisable efficiency, recurring billing, reporting, payment options, activity tracking and more.
At Tide, we also have our own invoicing software solution that you will gain access to once you open a business current account for free. We also have several accounting integrations that make it easy to pull in your business transactions from your preferred accounting software and reconcile them within our system on a daily basis.
One of the best ways to stay organised and efficient is to manage your business finances through either a desktop or mobile app. To learn more about our invoicing software and others, read our guide to the best invoicing software solutions for your small business.
Purchase orders and invoices are beneficial for small businesses. They help you maintain accurate, detailed records of purchases and sales for financial statements.
You can implement paper-based POs and invoice processing in your business, or you can use a digital solution. Going digital makes it easier to issue and refer to these documents when required.
Of course, not all businesses can afford to invest in a standalone solution, which is where alternatives like integrated PO and invoices come in.
With Tide, you can set up a free business account, register your business for free and take advantage of digital invoicing. Rather than using separate software, you can send invoices directly from the Tide app. And courtesy of the latest update to Tide’s integrated invoicing feature, you can now match payments to invoices and mark invoices as paid.
It’s really simple to use and allows you to be more efficient in validating payments.
Photo by Andrea Piacquadio, published on Pexels