Is a Purchase Order a Binding Contract?

A purchase order is a part of a contract between a supplier and a buyer based on the terms, conditions and executed master agreements the two parties have agreed to. But there is a lot more to this discussion than just a black and white definition. The purchase order represents so much more than just a binding contract. It is a document that can indicate the strength of a business relationship and it is also a way for a company to monitor its spending.

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The most common misconception about purchase orders is that they are only issued when a client uses a credit account with a supplier. Purchase orders are actually just as prevalent in the business to business sales world as an invoice. Most companies will not pay an invoice unless there is a purchase order number attached to it. Purchase orders are utilized on orders paid for in cash or by company credit card along with purchases made on corporate NET 15 or 30, 60 and up to 120 day accounts.

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When a company issues a purchase order to a supplier based on that customer's NET credit account, the customer is acting on good faith that the supplier will ship the product or supply the service. The customer has already made the necessary arrangements to accept the product or service, and the purchase may help to alter the future of the entire organization.

The supplier is preparing to ship a product or perform a service based on a NET purchase order under good faith as well. Based on the payment history of that client, the supplier is expecting to be paid within terms agreed for the product or service. The supplier is, in essence, agreeing to finance the purchase for the customer based on agreed terms.

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While a purchase order is a legally binding agreement, it is also part of a delicate business cycle that neither side wants to upset. The reason purchase orders have the terms of the purchase explained in great detail is in case either party decides to start legal action due to a breach. The last thing a supplier wants to do is start legal action against a client.

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In summary, a purchase order issued by a customer is only a component of the sales transaction. Many companies have a standard Master Service Agreement in place between the customer and its vendors. When analyzed as a combined component, it makes the transaction more detailed and spells out the expectations of each party. Vendors should always refer to the Master Service Agreement for more details about their obligations in dealing with the customer.

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If any legal action is taken by either party, the Master Service Agreement along with the purchase order will most likely be the guidelines used to settle the dispute.

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In the event the purchase order transaction or the receivable generated by the delivered goods referencing the purchase order is to be financed, then it is very important to make sure the purchase order finance company is aware of all the details in both the purchase order and the executed master service agreement.

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Why do factoring companies want to inspect the details in the contracts? The terms of sale is the most important attributes to review when financing is going to take place in the transaction. The finance company will determine the risk, exit strategy and advance it should allow in order to feel comfortable with financing the transaction. Some purchase order finance companies will not finance the transaction without understanding what the buyer and supplier have agreed to in writing.

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For example, are there any guaranteed sales clauses that may short pay the receivable, expiration dates that may cancel without recourse, or other conditions that can put the finance company in an upside down position if the transaction does not go as planned.

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Learn more on how to prepare an application for purchase order finance