Two critical documents used in the construction industry are purchase orders and invoices. Yet they are often confused and misunderstood. Although similar, each serves avery different purpose. The key difference between a purchase order vs. an invoice is who is sending it, and when they send it.
A purchase order (PO) is sent by a buyer to a vendor that serves as an official request to buy x product for x amount. An invoice is sent by a vendor, typically after goods and services are provided, and details the final amount that the buyer owes. Invoices will also include an itemized list and terms of the transaction.
The PO will initiate the transaction and will help manage project budgets and progress. While the invoice is a request for the final amount owed and helps bring the transaction to a close.
To better understand the relationship between the two, let’s look at an example. If while working on a project it is discovered that work has halted because a new hydraulic pump and various other materials are needed. An overview of a typical PO to invoice life cycle might look something like this:
Step 1: A resourcing need is identified by the buyer (hydraulic pump and additional parts/materials).
Step 2: A supplier or vendor is identified who can supply the materials for x amount.
Step 3: A purchase order is developed by the buyer that details what type of pump and materials are needed, how many are needed, shipment info, and agreed upon price.
Step 4: The purchase order is sent by the buyer to the vendor as an official request enabling the vendor to procure the materials.
Step 5: The vendor supplies the order, and then issues an invoice or bill that details the final amount owed by the buyer and a timeline for when they need to pay in full.
Now that we know what the difference between a purchase order and invoice is, let’s break each down in more detail.
What is a purchase order?
A purchase order is a document that serves as an official offer issued by a buyer to a seller that specifies types, quantities, shipment information, and agreed upon prices. It lets the vendor know that the buyer has full intention to honor a specific sale. It is an effective way to communicate to a vendor what you as a buyer are committed to buying and will serve to protect both parties down the road. In short a purchase order is an official authorization or request from a company to a vendor that a tool or material needs to be purchased.
A typical PO will vary depending on the industry and vendor but a typical construction PO will include:
- A unique PO number used for tracking and accounting purposes.
- Date the PO was submitted
- Address of both the buyer and vendor and any corresponding contact information
- Shipping address for the buyer
- Detailed line items specifying the material or product needed, quantity, unit price, and price totals
- Terms and conditions including delivery terms and method
What makes a purchase order important?
It acts as a contract between the buyer and vendor. They are very beneficial for both parties as they can be easily referenced if any disputes or disagreements arise due to price, shipment, or quality.
According to recent studies an estimated 98% of large construction projects go over budget or incur costly delays. Major reasons why include lack of organization, poor communication, and contractual misunderstandings. Purchase orders may seem like a tedious document to include for every project or purchase. However, they are crucial for building a conscientious business and serve as significant accounting and planning documents.
Purchase orders save time and money, and are a valuable mechanism for leveraging budgets and job costing. A properly managed PO system will avoid errors and help mitigate against unwanted or unexpected costs.
Most importantly, purchase orders provide protection. A successful business may feel confident in a handshake deal or take the word of a trusted long-time vendor. However, this should be avoided at all costs. It’s crucial to protect yourself should a problem or disagreement occur.
Having a robust purchase order and supplier invoice reconciliation system such as Knowify is essential. Using Knowify ensures that no one at your company will ever be confused again about whether a PO has been submitted on an important materials order.
What is an invoice?
In a typical business transaction, there are two parties involved: a buyer and a seller. This all seems straightforward but how much exactly does the buyer owe? What specifically are they paying for and how long do they have to make the payment? An invoice is issued to provide clarity on all of these questions and to officially set out all of this information.
In construction, an invoice is a document issued by a supplier or contractor officially requesting payment for any work or service that has been provided. It should be clear how much is owed, including an itemized list of goods and services provided and the terms of the transaction. In the construction industry invoices are key for progress billing. Keeping track of partial payments, late fees, deadlines, and materials and services are crucial for long-term and large-scale projects. Most large projects need to be billed on a percent-completion basis; further complicating matters, it is very common for those projects to be broken down into phases that are individually billed by their percent-completion. Thankfully, progress billing is a key feature offered by Knowify.
Invoices come in many different shapes and sized but typically they will include:
- Addresses and business information for both the buyer and seller
- Invoice number
- Date the invoice is created
- Terms
- Specific descriptions of the rate, quantity, and amount of goods and services.
- Tax amount per local and state regulations and law
- Total amount owed
It should be noted that an invoice is not the same as a sales receipt. The key difference is that an invoice is a request for a payment, and is issued before money is received. A receipt on the other hand, is issued after money has been received.
For the construction industry, it’s also important to set up invoices correctly based on billing style, such as AIA, progress billing, or requesting payments in full
What makes an invoice important?
An invoice is an important event from an accounting standpoint as it triggers the accounting entries in the books of both the buyer and seller and is a catalyst for a business to actually receive money that it’s owed. Although not legally binding by default, an invoice can be if agreed upon by both parties. It’s strongly recommended to take this route and secure it as a signed contract to help protect yourself and ensure payments should a party refuse to pay.
An invoice should be sent as soon as possible to ensure healthy cash flow. Most importantly, an invoice ensures proper accounting and documentation of all transactions which is essential for running an effective, and legal, business operation. Lastly, a proper invoice is a record of a transaction that will conveniently split out and identify tax dollars which is required by law for transactions involving registered businesses.
Summary
Both purchase orders and invoices serve as vital business functions for any construction project. It is important for project managers and business owners to know the difference and how each can be leveraged to make better business decisions. Investing in planning and accounting will go a long way in ensuring an efficient and lucrative project.