September 21, 2022
Explainer

Purchase orders vs. invoices: Guide for small businesses

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When navigating the procurement process for the first time, it can be incredibly easy to become confused about the difference between a purchase order (PO) and an invoice. While both documents often contain similar information, each has its own distinct purpose, and being able to understand and properly utilize each is critical to the financial performance of almost any business. 

In this article, we’ll cover the definition and significance of both documents, explain their differences, and explore how small businesses can use this information to improve vendor spend and expense management across their organizations. 

What is a purchase order?

A purchase order is a document issued by a company as a request for goods or services from a supplier. The initial purchase order is the first step in the procurement process and outlines as clearly as possible the products or services required, including details such as quantity, price, and date of delivery. 

Once a purchase order is finalized and approved by both the buyer and the seller, it becomes a legally binding document or record of the agreement between the two parties.  After the goods or services detailed in the purchase order have been delivered, the supplier will send a corresponding invoice to be paid by the buyer at a future date. 

Why are purchase orders important to streamline?

Understanding and using purchase orders correctly is critical for nearly all small businesses for a variety of reasons. Beyond being necessary for acquiring goods and services that are integral to the business, when used carefully and strategically purchase orders can provide small businesses with the following benefits: 

Tracking orders/inventory management 

Using a purchase order system allows businesses to easily track shipments and purchase activity in order to avoid costly mistakes like placing duplicate orders. For small businesses, the visibility provided by the PO system will become increasingly important as the company grows and inventory management becomes more difficult. 

Budgeting

Maintaining a thoughtful expense management strategy and not overspending on projects is critical for any growing business. In the absence of an organized purchase order system, businesses risk frequently miscalculating costs or the quantity of goods needed for a project. Over time, such mistakes can have a negative long-term impact on the bottom line.

Disputes

Relationships with vendors don't always run smoothly; deliveries might be arriving late, quantities may be off, or the price on an invoice could be different than what was originally agreed upon. In any of these instances, a purchase order can serve as a record of the transaction, and be utilized as evidence in the event of a dispute between a business and its supplier. 

What should purchase orders include?

A purchase order can be more or less complex depending on the size of the order and the specific goods or services being requested. Generally, however, a standard purchase order should include the following: 

-Name, address, and contact information of both the buyer and the vendor.

-Detailed description of required goods and/or services, including quantity 

-Unit price of goods and/or services

-Delivery date

-Any additional instructions for delivery/terms of the agreement

-Purchase order number (PON)

To get a better idea of what a purchase order might look like for your organization, try Ramp’s free purchase order template here. 

What is an invoice?

An invoice is a document sent to a business from a supplier after goods and services have been delivered. The invoice acts as a formal request for payment and contains the details regarding the items purchased, the unit cost, and the total amount due to the supplier. Many invoices will also include specific instructions or options for payment. Invoices are legally binding documents reflecting the official sale of goods, and the buyer must honor the payment terms as outlined in the agreement. 

Why is invoice creation so important for small businesses?

At the most basic level, invoices are important because they serve as reminders of purchases made and help businesses keep track of money owed to vendors. Similarly, vendors rely on invoices to request payment, and to keep track of money owed for delivering goods and services. But how invoices are treated across an organization has additional implications, and businesses should take care to optimize invoice management for the following reasons: 

Tax-filing

Tax season is never fun, but it can be an absolute nightmare if invoices aren't organized and properly recorded. In order to save time, money, and frustration, it’s critical to streamline accounting processes across the board, including how invoices are filed, categorized, and accessed.

Additionally, businesses might consider integrating automated invoice processing technology to increase oversight over payments due and eliminate the chance of missing an invoice on a tax statement. 

Aiding accounts payable/receivable 

As small businesses and startups get off the ground, it's critical to ensure that the company’s balance sheet is as accurate as possible to make bookkeeping less complicated as the business scales. All unpaid invoices will need to be properly organized and easily accessible to make accounts payable, or debts owed to vendors and suppliers, as transparent as possible.

Similarly, vendors need to create detailed invoices in order to keep track of accounts receivable, as outstanding payments owed to the company are important for accurately projecting future cash flow. 

Providing transparency to investors 

Invoices, whether related to purchases or sales, tell a story on the balance sheet about the overall financial health of the company. Naturally, existing and potential investors will be interested in how efficiently a company manages expenses across the organization and collects outstanding debts. 

What should you include on your invoices?

When you create an invoice you should add as much detail as possible to avoid any confusion about the products or services being purchased as well as the associated cost. This will help minimize disputes and prevent delays in payment caused by inquiries regarding the invoice. Additionally, businesses often choose to customize the presentation of their invoices to reinforce brand recognition. 

At the bare minimum, a typical invoice should include the following: 

-Name, address, and contact information of both the buyer and the vendor.

-Invoice number

-Date of invoice

-Detailed description of required goods and/or services, including quantity 

-Unit price of goods and/or services, including value-added tax rate (VAT)

-Total amount due

-Any additional instructions regarding how the invoice should be paid

Follow the steps below to create your own invoice, using the example here as a reference. You can also download a sample invoice here.

Purchase orders vs invoices

While both purchase orders and invoices relate to the purchase of goods and services, they are two entirely separate documents with different intended use cases. The easiest way to remember the difference is to consider who is issuing the document, and at what point in the procurement process the document is being issued. 

With that in mind, the two primary differences between a purchase order and an invoice can be described as follows: 

1) Purchase orders are issued by the buyer to the seller as a request for goods or services. Invoices are issued by the seller to the buyer as a request for payment. 

2) Purchase orders are issued before the delivery of goods and services. Invoices are issued after goods and services have been received. 

Purchase orders and invoices also differ in terms of layout, as well as the specific information contained in each document. For example, an invoice includes the value-added tax on the price of goods, whereas the purchase order does not. Additionally, the purchase order might include instructions regarding how the item should be prepared or delivered, whereas the invoice merely confirms which items have been purchased and the associated cost. 

What are the similarities between purchase orders and invoices?

Purchase orders and invoices are different documents with different use cases, however there are a number of similarities that might result in unnecessary confusion. Here are a few of the main similarities between the two:

-Both relate to the purchase of goods and/or services

-Both include descriptions of goods and/or services being purchased, including quantity

-Both include the unit price of goods and/or services.

-Both have implications for budgeting and expense management 

What makes purchase orders and invoices so integral to businesses?

Now that we’ve defined purchase orders and invoices, and touched briefly on the individual importance of each, we also need to highlight the broader significance of both documents as it relates to an organization's greater financial management responsibilities. Cultivating meticulous accounting processes across the board is essential for any company, particularly for small businesses and startups as they work toward establishing a sustainable business model. 

Here are just a few reasons small businesses should not only understand how to use documents like POs and invoices but also strive to maximize the benefits of each by streamlining accounting processes wherever possible: 

Budgeting and project management

Strategic and efficient project management is crucial for small businesses looking to grow their operations, and budgeting for a project in a way that doesn’t result in overspending or overstocking can present a considerable challenge for new business owners.

Approaching purchase orders with a heightened understanding of available funds can make a world of difference and prevent simple mistakes, and achieving this includes not overlooking unpaid invoices or pending cash flow as reflected in accounts receivable.

Expense management

Similarly, understanding and properly utilizing POs and invoices benefits a company’s broader ability to manage expenses throughout the organization. When the accounting department fails to implement comprehensive spend controls and invoice reconciliation requirements, businesses often end up overspending on projects, placing duplicate orders, or entirely losing track of how much was spent and what was purchased. 

Financial planning

Whether it’s conducted by the accounting department or a designated financial planning and analysis (FP&A) team, businesses can leverage financial reporting, including POs and invoices, to project future growth and map out ways to improve the company’s overall operating model. This might mean identifying instances of overspending or poor budgeting related to project management, or reviewing invoices to determine how to eliminate unnecessary costs from the balance sheet.

Naturally, an organization’s ability to gather key insights and plan for the future will be heavily dependent on the strength of its financial reporting and accounting processes. 

Unlock the future of spend management with Ramp

As your small business or startup begins to take off, chances are you won’t have too many problems understanding and utilizing purchase orders and invoices. But while cutting through the confusion surrounding these two documents is one thing, incorporating them into the bigger picture and optimizing your procurement and spend management processes is another. 

This is where the Ramp platform comes in: By centralizing financial management processes and replacing time-consuming, manual accounting procedures with automation, not only does keeping track of financial documents becomes effortless, but new methods are continuously revealed for cutting costs and improving your organization’s bottom line. 

At a glance, here’s what you can expect to accomplish after implementing Ramp's vendor management and spend control solutions: 

Streamline procurement

Procurement is often bogged down by manually calculated purchase orders and drawn-out approval processes. Ramp streamlines procurement across the board by introducing a centralized platform that allows for a seamless, automated approval process with real-time alerts, providing employees with access to the services they need exactly when they need them.

Eliminate wasted spend

Certain SaaS platforms may be critical to your operation, but in the absence of comprehensive oversight of active subscriptions, businesses often continue paying for services that aren't being utilized. Ramp not only enhances visibility, revealing all instances of wasted spend from a centralized location, but allows automated spend controls to be enforced, easily restricting how much team members spend on services, and which individual vendors can charge your company. 

Automate outdated processes

From collecting and matching receipts, to expense categorization and bookkeeping, businesses today waste too much time and too many resources manually executing tedious processes. Ramp’s tools can be used to automate all of the above, saving accounting teams countless hours that would be better spent on strategic financial planning, dramatically increasing accuracy, and reducing the possibility of human error. 

Finally ready to transform your accounting processes and unlock the future of spend management with Ramp? Click here to get started. 

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