In the construction industry, just like any other, there are plenty of nuances that can be confusing. In this entry, we will talk about purchase orders, contracts, their differences and why that matters for your business.
First, we must define a couple of key terms.
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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 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.
Purchase Orders vs Contracts: The Differences
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 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.
Here are some of the differences between the two:
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.
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 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.
Purchase Orders are generally short-term agreements for procuring goods or services for a specific project phase, whereas Contracts can span the entire duration of a construction project, from commencement to completion.
Terms and Conditions:
Purchase Orders typically contain minimal terms and conditions, primarily related to pricing, quantities, and delivery, whereas Contracts include comprehensive terms and conditions covering various aspects such as warranties, indemnities, payment terms, and dispute resolution mechanisms.
Purchase Orders are relatively easier to modify or amend, often requiring simple revisions to quantities or specifications. Contracts may require formal change orders or amendments to alter terms, scope, or conditions.
Purchase Orders typically involve the buyer (e.g., construction company) and the seller (e.g., supplier or subcontractor), whereas Contracts may involve multiple parties, including owners, contractors, subcontractors, architects, and engineers.
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:
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.
The determination of whether a Purchase Order becomes a Contract in the construction industry depends on various factors, including the intentions of the parties, the content of the document, and compliance with legal requirements and industry norms. Is it preferred to consult legal professionals experienced in construction law who can provide clarity and guidance in such situations.
Contracts set forth performance standards and quality requirements for the construction work, including specifications, standards, and inspection procedures, whereas Purchase Orders typically focus on quantities and specifications of materials or services.
Purchase Orders can often be terminated with minimal notice and without significant repercussions. Contracts are a legal document that may include provisions detailing the circumstances and consequences of termination, such as termination fees, liabilities, and dispute resolution mechanisms.
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.