What it means
For non-finance managers, understanding purchase orders is vital for keeping spending under control. When your team needs supplies, hardware, or external services, raising a purchase order creates a paper trail before any money actually changes hands.
This formal request prevents unauthorised purchases and ensures everyone agrees on costs and delivery dates upfront. In practice, the purchase order process involves several clear steps.
First, an employee identifies a need and creates the document. Next, a manager or finance team member reviews and approves the request to check that it fits within the departmental budget.
Once approved, the document goes to the supplier, who fulfils the order and sends an invoice later. Matching the purchase order against the final supplier invoice and the delivery note is a core internal control known as a three-way match.
This check ensures your business only pays for items it actually ordered and received at the correct price. Without purchase orders, companies often struggle with surprise bills, duplicate orders, and poor cash flow visibility.
A purchase order is like ordering from a restaurant menu. You tell the waiter exactly what you want and how much you expect to pay, and the kitchen prepares the meal based on that clear instruction.
In practice
Real-world examples
Example 1
A cafe owner uses a purchase order to order 50 bags of coffee beans from a supplier for $500, locking in the price and delivery date before the transaction happens. When the delivery arrives with only 45 bags, the owner can point to the purchase order and pay for 45 bags only. The document settles any dispute quickly.
Example 2
A digital marketing agency issues a purchase order to a freelance designer for $3,000 to create campaign graphics. The order lists the number of designs, the deadline and the payment terms in writing. When the designer delivers, the agency checks the work against the order before releasing payment.
Example 3
A manufacturing firm sends a purchase order for $10,000 worth of steel parts to a local factory. The order specifies the part numbers, quantities and delivery date, so the supplier ships exactly the materials needed for production. The finance team also records the $10,000 as a commitment, so the budget shows what is already spoken for.
Think of it
A purchase order is like ordering from a restaurant menu. You tell the waiter exactly what you want and how much you expect to pay, and the kitchen prepares the meal based on that clear instruction.
Formula
Calculation
Variance = Final Invoice Amount - Purchase Order Amount
Worked example. A purchase order is raised for $1,000 of materials, but the final invoice arrives at $1,150.
- Variance = $1,150 - $1,000 = $150 over the purchase order
The variance is 15% of the order value ($150 divided by $1,000). Under a three-way match, the invoice would be held rather than paid, because the price does not agree with the purchase order. The buyer then asks the supplier whether the extra $150 is for freight, extra items or a pricing error, and only pays the correct amount once the difference is explained or the purchase order is formally amended.Case study
Seen in the real world
This is a fictional, illustrative scenario. GreenLeaf Landscaping, a growing garden maintenance business, experienced unexpected cash flow shortages because field managers were buying plants and tools without centralised tracking. To fix this, the finance director introduced a strict purchase order policy. Before ordering turf or timber worth more than $100, managers had to submit a purchase order for approval. During the first month using this system, GreenLeaf caught three duplicate orders totalling $1,200 and negotiated better bulk discounts with approved nursery suppliers.
By quarter end, the business reduced its unplanned supply expenses by 15%. The finance team could finally forecast monthly cash outflows accurately because every major expense was logged in advance through the purchase order system. The change was not without friction. Two field managers complained that approvals slowed urgent jobs, so the finance director added a rule that orders under $500 could be approved by a team leader within the same day, while larger orders went to finance. That compromise kept the control in place without stopping the crews from working.
Watch out
Common mistakes
- Placing verbal orders with suppliers without creating a formal purchase order first.
- Failing to match the final supplier invoice against the original purchase order before paying.
- Allowing staff to approve their own purchase orders, which bypasses internal spending controls.
Questions
People also ask
What is the difference between a purchase order and an invoice?
A purchase order is created by the buyer before the sale happens to request items. An invoice is created by the seller after the goods are delivered to request payment.
Is a purchase order legally binding?
Yes. Once a supplier formally accepts a purchase order, it forms a legally binding contract outlining the goods, prices, and delivery terms.
Do small businesses really need to use purchase orders?
While small teams might manage without them initially, using purchase orders becomes essential as soon as you have multiple people spending company money or need to track inventory.