The Nuts and Bolts of a Purchase Order

A purchase order is an offer to buy a specified product in a specified quantity and at a specified price. Once accepted it becomes a contract between buyer and seller. It is likely you buy raw materials, components or even contract labor on a regular basis. Too many small businesses handle these transactions with nothing but a verbal order often with little or no discussion on price. Many times they routinely sign the vendor’s proposals along never considering the onerous terms in small print on the reverse side. If you prepare a written purchase order it allows you to specify the exact product, state the price you expect the pay and the terms of the agreement. If you order 300 blue widget bolts you purchase order may say 300 each blue widget bolts with nut part number xyz704 at a price of $.35 per unit. It avoids the confusion of changing parts or changing prices. And the onerous terms on the reverse side can be to your advantage not theirs. Have you ever ordered a part and after the delivery is received and the parts are already in production discovered a price increase you didn’t know about. After the parts are half gone is the wrong time to discuss price. If you send the order and they send the parts then there is no argument to be made. In our home building business purchase orders were very detailed. For example, if we were writing a purchase order to a drywall contractor we including specifications (what materials we expected to be used and what the final product was to look like and perform), scope of work (what was included materials, labor, clean up, finishing), how it was to perform over time (no nail pops, no visible seams in normal light), the price to be paid and when it was to be paid (30 days from completion.) If possible you should develop unit prices for the items or services you need regularly. It keeps the price from creeping up and keeps vendor honest. Once you are comfortable with the system you should develop a system where you pay off the purchase orders. When we were building homes we would send out the purchase order in duplicate – one white and one pink. When the work was completed the trade contractor had our field superintendent approve the work and the contractor returned the pink copy as their invoice. We paid off the purchase order. If there was extra work done then the contractor had to get the superintendent to write a revision to the purchase order. The revision system did a couple of things for us; it highlighted contractors who were constantly going over budget and made our superintendents responsible for tracking and reducing changes. The superintendent had to fill out a report on each revision giving the reason for the change. I reviewed these forms monthly. It allowed us to pinpoint problems and work to correct them. In one case we found that our cleaning contract on one subdivision was getting more revision than on another. Upon investigation we discovered that one of our superintendents was not making sure the home was ready before they brought in the cleaning contractor. With a little training we reduced the overage. After we instituted the purchase order system we reduced our budget variances went from almost five percent of cost to less than one percent. Our trade contractors screamed when we told them we were paying off of purchase orders but within a few months they loved it because the system reduced paperwork and spread up payments. Your staff will also likely think it is too difficult in the beginning. Stick to it and it will be one of the best things you can do for your company.

About the Author: Thomas Robinson has over thirty years of entrepreneurial business experience from managing a specialty retail store to running a successful land development and home building business. He is author or MAY I BORROW YOUR WATCH?