Purchase Orders versus Contracts: What’s the Difference?

In the construction industry, just like any other, there are plenty of nuances that can be confusing. In this entry, we will cover the importance of purchase orders, contracts, their differences and why they matter for your business. 

First, we must define a couple of key terms.

What is a Purchase Order?

A purchase order (PO) is a document sent from buyers to sellers requesting an order for a product. When accepted by the seller, a legally bound contract occurs through the transaction between the buyer and the seller: money in exchange for the product. The buyer’s role is to create a detailed purchase order that includes descriptions, quantities, discounts, and product prices to avoid confusion. Ideally, they should also state payment terms and shipment dates and conditions. Typically, the purchase order results from a purchase order request.

There is a blanket purchase order, also known as a call-off order or blanket purchase agreement, that the customer places with a supplier. This type of PO allows for multiple delivery dates over a negotiated period to set predetermined pricing. In addition, blanket purchase orders are also legal documents once accepted by the supplier. To be compliant, however, you still need a formal contract.

What is a Contract?

A contract is a document that describes the products sold, the agreed prices, and the terms and conditions. Contracts also indicate the value and number of purchase orders and invoices for the project. A fixed price contract in construction is a pricing method that sets the total established price upfront for the entire project, simplifying budgeting and planning.

The difference between a contract and a purchase order can be confusing. The factors listed below will help you decide which document to use when making your next purchase for your business.

Purchase Orders vs Contracts: The Differences

The difference between purchase orders and contracts must be clear for your business to proceed confidently. At first look, both of these documents are similar, so distinguishing them can be complicated.

It is confusing that POs become contracts when accepted, but only some contracts are a PO. When deciding which document to use, one should disregard the misconception that contracts are more detailed than POs, and rather view POs as a one-time contract instead.

Here are some of the differences between the two: 

Long Term vs. Short Term:

The main difference between the two documents (Purchase Orders and Contracts) is their duration. While purchase orders represent single business transactions that move the project forward, contracts are used to register the long-term agreement between your business and the vendor. Contracts may also include renewal options.

Used for Different Items:

While contracts are typically used for service payments, purchase orders are used to purchase items. Companies should consider what they are buying before deciding which method to avoid mixups. It is also necessary to know your buying objectives beforehand to determine what type of document is best.

Legal Nature:

Purchase orders are commercial documents, while contracts are legally bound documents. Purchase orders only become legally binding documents once the seller accepts them, whereas a contract is the primary legal document from the start of each project. They also differ because purchase orders have zero value unless approved by the product or service provider, while contracts paint a clear picture of the entire project.

Duration: 

Purchase Orders are short-term agreements for procuring goods or services for a specific project phase or activity. Contracts, on the other hand, can span the entire duration of a construction project.

Terms and Conditions: 

Purchase Orders typically contain limited terms and conditions, primarily related to pricing, quantities, and delivery. They have a purpose of moving the project forward in an accountable manner. Conversely, contracts include comprehensive and detailed terms and conditions, such as warranties, indemnities, payment terms, amendments, and dispute resolution mechanisms.

Amendments: 

Purchase Orders are relatively easier to modify or amend, often requiring simple revisions to quantities or specifications within an already accepted workflow. Contracts, on the contrary, may require formal change orders or amendments to alter terms, scope, or conditions that require multiple stakeholders collaboration and agreement.

Parties Involved: 

Purchase Orders typically involve the buyer (e.g., construction company) and the seller (e.g., supplier or subcontractor), whereas Contracts may involve multiple stakeholders, including owners, contractors, subcontractors, architects, and engineers.

Risk Allocation:

Contracts have greater legal value. In a high-risk situation, they are the ideal choice to use because they identify responsibilities and reduce risk exposure for all parties. Contracts can also clearly define performance standards and what to do in case they aren’t met. Often, when using a contract, POs should be utilized in addition to improve transparency and accountability because contracts do not state quantities and delivery times.

Terms and Conditions: 

Terms and conditions are typically listed in both types of documents. The difference is that terms and conditions are more specific in contracts given that they are the primary legal document in any project. Contracts should be used when the scope of work, performance standards, and change management requests need clarification and may affect multiple processes or stakeholders. In other words, a contract is used when there are a more complex set of terms associated with the purchase than the ones typically stated in the PO.

Determining whether a Purchase Order becomes a Contract in the construction industry depends on multiple factors, including the intentions of the parties, content, and compliance with legal requirements and industry norms which may change given the state. It is advisable to consult legal professionals in construction law fields who can help trade contractors and contractors navigate such situations.

Performance Standards: 

Construction contracts usually specify performance standards, quality requirements, inspection procedures, etc. Purchase orders, on the contrary, focus on quantities and specifications of materials or services.

Termination:

Purchase Orders can often be terminated with minimal notice and without significant repercussions for stakeholders.  Contracts, in opposition, are the legal documents that may include provisions detailing the circumstances and consequences of termination, including termination fees, liabilities, and dispute resolution mechanisms available. 

How eSub helps with Purchase Orders and Contracts

eSUB is a cloud-based project management platform built especially for subcontractors. It seamlessly integrates with leading construction software systems so you can easily modernize your business.

With our solution, you and your team will be able to: 

• Implement a reliable purchase order software to streamline the creation, tracking, and approval of purchase orders.
• Compare estimated costs to actuals produced in POs for material cost and productivity tracking.
• Update dates of entry and delivery, shipping information, and line items, like cost codes, part numbers, and more.
• Establish clear communication channels with suppliers to ensure timely deliveries and accurate order fulfillment.
• Review and update purchase order processes to identify and address issues.
• Train employees on the importance of purchase orders and best practices for managing them effectively.

eSUB organizes all of your project information in one place, allows for smooth collaboration, and streamlines communication through its intuitive interface. It also works on your mobile