Purchase Orders, Purchase Agreements, and Contracts: What's the Difference?

When managing contracts, you will probably encounter purchase orders (POs), purchase agreements (PAs), and contracts. At first glance, they appear similar, as parties often use them to make purchases. However, each document has different uses. For instance, POs are usually for routine orders, while contracts and PAs are better for complex, high-value deals.

Read this guide to learn more about the differences between these documents and when to use each.

A purchase order is a document that a buyer sends to a seller to order a specific product(s). It includes the following information:

• Detailed descriptions of the product(s)
• Number of items
• Date of purchase
• When the order will arrive
• Cost per unit and total cost price

Once the seller receives the PO and approves the purchase, they will send an invoice. Most sellers include the PO number on the original PO to help ensure the information on both documents is the same.

A purchase agreement is a legal document between two parties to purchase and sell a product or service. It becomes a legally binding contract once both parties sign it.

PAs focus primarily on both parties’ expectations, rights, and duties. Most cover the following:

• What goods or services are being bought or procured
• Price and payment
• Definitions
• Choice of jurisdiction
• Responsibilities of each party
• Agreement term
• How to terminate the agreement
• Remedy for breach of contract
• Warranty
• Place and acceptance of the order

A contract is a written or spoken agreement between two parties that creates a legal responsibility. Contracts establish clearly defined remedies and penalties in case of a contract breach. A contract breach violates any of a binding contract’s established terms and conditions.

Contracts must have the following essential elements to be enforceable:

1. Offer: A tentative promise made by one party (the offeror) to another in exchange for the other party’s performance. For example, Party A gives Party B $80 to shovel all the snow in Party A’s driveway.
2. Acceptance: An expression, through deeds or words, that both parties agree to the contract terms. To form a binding contract, the parties should express acceptance in a manner requested, authorized, or reasonably expected by the offeror.
3. Awareness: Evidence that both parties understand and agree to be bound to the contract’s obligations. Awareness is also called “a meeting of the minds.”
4. Consideration: Both parties must offer something of value in exchange for something they are not already entitled to. Consideration can be monetary payment, a promise to do something or refrain from doing something, forbearance, property, or performance, but it cannot be a gift.
5. Capacity: Each party to the contract must have the legal capacity to understand what they are signing. People who may lack the legal capacity to sign a contract include minors, people with a brain disorder, people without a sufficient understanding of the contract’s language, and people under the influence of alcohol and drugs.
6. Legality: All contracts are subject to the laws of the jurisdiction in which they operate. Accordingly, a contract for an illegal product or action cannot be enforced.

Despite their similarities, POs, PAs, and contracts have many key differences.

Buyers often use POs to purchase supplies, inventory, or low-risk services. Typical scenarios where POs may be appropriate include buying office supplies, procuring printing services like brochure printing, and purchasing information technology (IT) equipment. A PO is not a legally enforceable contract until the seller signs it, indicates acceptance in writing, or provides the ordered goods.

In contrast, companies typically use PAs for large, high-risk transactions, such as buying and selling real estate, mutual preference sales, and motor vehicle purchases. Because deals involving PAs are riskier, these PAs usually contain comprehensive details about the deliverables, project timeline, and parties’ expectations, duties, and rights. Accordingly, they tend to be much lengthier than POs. Additionally, a PA is not legally enforceable until both parties sign it. A seller can only accept a PA by signing the document—providing the goods alone does not indicate acceptance.

Finally, a contract is an agreement between parties that creates mutual, legally enforceable obligations. Contracts can take many forms and serve many purposes. Standard enterprise contracts include PAs and non-disclosure, non-compete, and employment agreements.

Due to their differences, POs, PAs, and contracts offer different benefits.

Benefits of using POs include:

• Fewer errors: POs provide a clear record of which clients ordered what.
• Improved inventory management: POs help you track what products should arrive at your business. Match them with invoices to see if everything has arrived in time.
• Insights into company performance: POs can help you plan for the future, especially if you use a procurement system. Most procurement systems can store and analyze POs and offer critical insights into enterprise performance. Some may even provide purchase order templates for streamlining workflows.

Advantages of using PAs and other contracts include:

• A reliable record of responsibilities, rights, and obligations: PAs and other contracts detail what duties each party has to one another, when and how they should perform these duties, and what constitutes a breach of contract.
• Legal enforceability: Unlike POs, which are not legal documents, PAs and other contracts are legally binding. This means you can take legal action when another party breaches the terms of the contract. The contract will also explain in which jurisdiction you can pursue your legal action and what remedies you can obtain.
• Reduced disputes between parties: While creating and editing contracts, you will have many opportunities to discuss, redline, edit, and negotiate terms and conditions with other parties.
• Confidentiality: When working with another entity, parties may expose sensitive business information about each other. They can ensure confidentiality by including non-disclosure and confidentiality clauses in their written contract. POs do not have these clauses.

Which document is best for the situation depends on the nature of the purchase and your industry. For instance, parties typically use PAs for real estate transactions, not POs.

Parties generally use a mix of contracts and POs when making repeated purchases and deliveries over time. For example, you can use a PA to state the rights and responsibilities of the agreement and a PO to request office supply deliveries.

POs are usually for relatively simple purchases or repeat purchases of the same type(s) of products. For instance, you may want to use POs to purchase IT equipment, office supplies, and other regularly used goods.

PAs are generally for complex and expensive transactions. For example, suppose you are buying $200,000 worth of equipment. In that case, you will probably use a PA because it is legally enforceable and creates a reliable record of each party’s obligations, responsibilities, and rights. As a result, you can pursue legal action and obtain remedies if the other party breaches the agreement.

Purchase orders and contracts like purchase agreements are distinct documents. Contracts generally contain more information about parties’ duties, rights, and remedies because they regulate high-risk, expensive transactions. Meanwhile, POs typically only detail the specifics of the product(s) the buyer wants to purchase.

POs and contracts also have different uses. Most companies use POs for simple purchases and reserve contracts for more complicated and expensive transactions. They may also use a mix of POs and contracts when making repeated orders over a long period.