Purchase Orders versus Contracts: What’s the Difference?
For your business to proceed with confidence, it is important that the difference between purchase orders and contracts is clear. At first look, both of these documents are similar, so distinguishing them can be complicated.
It is confusing is that POs become contracts when accepted, but not every contract is a PO. When deciding which document to use, one should disregard the common misconception that contracts are more detailed than POs, and view POs as a one time contract.
To clarify, let us first define the two documents.
What is a Purchase Order?
A purchase order (PO) is a document sent from buyers to sellers with a request to order a product. When accepted by the seller, a legally bound contract is formed through the product transaction between the buyer and the seller. The buyer’s role is to create a purchase order and it should include descriptions, quantities, discounts, and prices of the product. Ideally, they should also state payment terms and shipment dates. Typically, the purchase order is the result of a purchase order request, AKA a purchase requisition.
There is a blanket purchase order, or also known as a call-off order or blanket purchase agreement, it is a PO that the customer places with a supplier. This allows for multiple delivery dates over a negotiated period of time in favor of predetermined pricing. Additionally, blanket purchase orders are legal documents after they are accepted by the supplier, however, you still need a formal contract.
What is an invoice?
Invoices are business documents that are directed around a particular transaction. They are also known as bills, statements, or sales invoices. They are seen as the reciprocal of a purchase order because they include items sold, prices, date of shipment, delivery and payment terms. The purpose of invoices is to indicate the amount of money the buyer owes to a seller and to indicate that an order is confirmed.
The difference between an invoice and a PO is that the buyer drafts the PO and the sellers draft the invoices. While both documents involve similar details, invoices lack the technical information that POs contain (ie. due date of materials). Subcontractors use POs to order goods and services, and suppliers use invoices to show when payments are due. Moreover, POs define the contract of the sale, while invoices confirm the sale
What is a Contract?
A contract is a document that describes the products being sold, sets agreed prices and defines terms and conditions. Contracts also indicate the value and number of purchase orders and invoices. A fixed price contract in construction is a pricing method which sets the total established price upfront for all related activities throughout the project.
As you can see, the difference between the two is hardly apparent. Hopefully, the factors listed below can help you decide which document to use when making your next purchase for your business. Purchase orders and contracts are used differently, though they both are crucial in the purchasing process.
Long Term vs. Short Term
The main difference between the two documents is their duration. While purchase orders represent single business transactions, contracts are used to register the long term agreement between your business and the vendor. Contracts may also include renewal options.
Purchase orders are commercial documents while contracts are legally bound documents. Purchase orders do not become legally binding documents until they are accepted by the seller whereas a contract is a legal document from the start. They also differ because purchase orders have zero value unless approved by the provider of the product or service.
In doing a business transaction with more risk, it is better to use a contract because they have greater legal value. In a high-risk situation, contracts are better to use because they can identify responsibilities and reduce risk exposure. Contracts can also clearly define performance standards. Often, when using a contract, POs should be utilized in conjunction because contracts do not state quantities and delivery times.
Terms and Conditions
It should be remembered that terms and conditions are typically listed in both purchase orders and contracts. The difference is that terms and conditions are more specific in contracts. Contracts should be used when the scope of work, performance standards, and change management requests need to be made clear. In other words, a contract is used when there are a more complex set of terms associated with the purchase than stated in the purchase order.
Used for Different Items
While contracts are typically used for the payment for services, purchase orders are used for the purchase of items. Companies should consider what they are buying first before deciding which method of purchase to use. It is also necessary to know your buying objectives in advance so you can decide which type of each document it is best to use. When choosing between which one to use, consider the situation and select the best option.
Purchase orders and contracts are both documents used by construction businesses to purchase goods or services. Although they are similar, the differences between the two should be noted so that they can be used properly in their suited situations. Purchase orders should be used for single short term purchases while contracts should be used to foster long term buying relationships. It should also be understood that contracts have greater legal value so they should be used in deals with greater risk.
Choosing between using contracts or purchase orders has significance, and each document is a different approach to purchasing. Instead of choosing between the two randomly, companies should first consider the situation and then choose the better option. It is also essential that construction firms have a great software program to manage these types of documents for every project.
eSUB’s construction purchase order software manages POs for real-time job costs. When you use purchase order software there are many benefits:
— complete purchase order tracking
— faster approvals
— control access permissions
— real time payment status