Why purchase orders help small businesses manage inventory and cash flow
Everything you need to know about purchase orders to run your business smoothly
Every business has to order materials, supplies, and products in order to function. Every product you use – from printer supplies to wholesale products you resell – all have to come from somewhere.
Many small businesses start out with the owner making their own purchases, investing time and money in the business, and building stock. Over time it becomes necessary to calculate stock turn, which is the number of times a particular item is used or sold within a particular time period.
But you can’t calculate anything without having an accurate account of your own inventory and how much you spend on it. Purchase orders fulfill this need and set the stage for workflow optimization through process automation and other time-saving steps down the line.
What is a Purchase Order?
A purchase order is a legally binding contract between a buyer and a supplier. It identifies exactly what items the buyer agrees to purchase, the price of each item, and the terms of delivery and fulfillment.
Buyers generate purchase orders to stipulate the terms of business transactions to their suppliers. Large enterprises often do this through a dedicated purchasing department that reports to accounting. But small businesses can also capitalize on efficient purchasing proccess to improve inventory management and control cash flow better.
Today’s businesses often use digital forms to agree to purchase order terms and conditions. This is an example of what a digital purchase order request form looks like:
As the purchase order example shows, the form contains all of the items the buyer wishes to purchase in a single, easy-to-manage document.
It clearly communicates all of the relevant information that a supplier would want to know in order to fulfill the order. A purchase order should include the following elements:
- Purchase order number (it is the number that you and your supplier will refer to from order taking to order delivery and potential product returns. Each PO number is unique.)
- Payment terms and invoicing address.
- Delivery details: delivery dates, address, instructions.
- Cost per unit, quantity, total, taxes and discount options.
- A variety of customizable fields that relate to the service the supplier offers.
What’s the difference between a Purchase Order and an Invoice?
Buyers generate purchase orders and send them to suppliers in order to authorize, process, and fulfill the transaction. Invoices work the opposite way – when a supplier issues an invoice, it means the transaction has already taken place. The supplier generates the invoice and sends it to the buyer.
Advantages of using Purchase Order Forms
Businesses that use purchase orders are able to enjoy advantages that would not be available to them otherwise. The purchase order is a legally binding document. Use it to establish a sense of trust that allows you to purchase items on account, potentially delaying payment in order to move towards a more efficient cash conversion cycle.
With a faster cash conversion cycle in place, your business could finance growth without having to resort to expensive financial instruments, issuing stock, or borrowing. This allows small business owners to leverage some attractive benefits:
- Improve Cash Flow. Maximizing the amount of time it takes you to pay for your outstanding purchases is good business. Purchase orders are one of the most important and overlooked tools for managing cash flow when dealing with vendors and suppliers.
- Avoid Late Payments and Processing Delays. Purchase orders allow small businesses to begin the accounting and recordkeeping process from the moment they reach an agreement with a vendor. This helps businesses avoid stressful accounting backlogs.
- Optimize Accounting. When you create a purchase order and submit it to a supplier, you stipulate the terms of the transaction. Once the supplier agrees, you can begin accounting for the order from that moment – there is no need to wait for further action on the supplier’s part like you would with an invoice.
- Obtain Better Visibility of Your Cash Flow. Without purchase orders, there are documents correlating outstanding purchases that have yet to be fulfilled with payment for those orders. Purchase orders give you immediate visibility into upcoming payment obligations, so you can better understand your current cash flow situation in real-time.
The bottom line is that the better you manage your cash flow and inventory velocity, the more likely you are to have cash on-hand when you need it.
Getting a head start on accounting for business purchases can be a competitive advantage all on its own, but process automation turns the purchase experience into a streamlined system that generates real profits.
For instance, imagine a business that issues its own purchase order forms and develops an automated management system for handling those purchase orders. This business will be able to accomplish a lot of things with the click of a single button:
- Automating Payment Terms Fulfillment. If a supplier requires payment 30 days after the order is made, the buyer could program payments to be made at exactly that time. This would maximize cash flow potential, since its possible some of those purchases begin making profit during that period of time.
- Accounting for Payments. Although the buyer does not necessarily need to pay immediately, the buyer can begin accounting for future payments proactively. This ensures that the appropriate sum of money is available in the purchase order system from the moment the order is made.
- Optimizing Orders. Ordering the right quantity is strategic for your business to balance between low storage costs and being able to meet customer demands. Calculating your reorder points and knowing which products are to be reordered at any given time will help you increase your sales and lower your costs.
- Automating Inventory Management. A comprehensive purchase order system could automatically update inventory when suppliers fulfill orders. This removes the need for time-consuming manual data entry and streamlines the entire administrative process.
- Gain Visibility of Your Stock Levels. With purchase orders, you get to know ‘upcoming’ quantities in your stock levels report, in addition to available quantity and reserved quantity through customers sales orders.
- Calculating Stock Turn. With real-time inventory figures and the cost of new inventory digitally streamlined, the business can accurately calculate stock turn at any time. This allows the business to make better decisions based on its current financial state and avoid guesswork.
All of these benefits serve to make the purchasing order process simpler and more accurate. Automation reduces the potential for error while maximizing the speed of communication. Instead of your accountant sending an email, a customized system updates itself based on real-world purchase data that you can analyze and monitor at any time.
If you’re enthusiastic about getting started on proactive inventory optimization and process optimization for your business, you’ll need a purchase order template that you can easily modify to use with your business. Here’s one you can download and use right now. Make it part of your purchase process and start running your business more efficiently!