What is a Back Order
A back order is a customer order that has not been fulfilled. A back order generally indicates that customer demand for a product or service exceeds a company's capacity to supply it.
Total back orders, also known as backlog, may be expressed in terms of units or dollar amount.
BREAKING DOWN Back Order
Sometimes when a company makes an order for a good, a company or store may have run out of stock in its inventory. A company who has run out of the demanded product but has re-ordered the goods would promise its customers that it would ship the goods when they become available. A customer who is willing to wait for some time until the company has restocked the merchandise, would have to place a back order. A back order only exists if customers are willing to wait for the order.
A company may have back orders if they run out of the stock in their stores, in which case, it can just place a new order to restock its shelves. A company may also have to take back orders if its suppliers have run out of the resources and raw materials necessary to manufacture the demanded goods. In this case, the company will have to wait until the manufacturing company or supplier has gotten the resources to commence production. Using this example, the supplier would have a back order from its retailers who would also have back orders from their final customers.
A company that utilizes the just-in-time (JIT) inventory management approach will usually have back orders, since it will only order and receive inventory for products as they are demanded. Companies would also have an increase in back orders during the holiday period or when they have a product that is trendy or in high demand.
Companies have to walk a fine line in managing their back orders. While consistently high levels of back orders indicate healthy demand for a company's product or service, there is also a risk that customers will cancel their orders if the waiting period for delivery is too long. This is less of a risk for innovative products with strong brand recognition in areas such as technology.
Analysts would usually monitor how well a company manages its inventory by measuring its back orders. A company with too many back orders may force its customers into the folds of competitors. This could lead to a loss of market share, lower revenue, and a smaller than anticipated bottom line for the company. Including the intangible costs associated with lost clients and sales, a company with a large back order may also face an increase in tangible costs, such as shipping costs. In order to make good on its promise to deliver at a certain time, the company may have to pay extra to receive the goods on time, and to deliver to clients. In addition, the company may also have to pay its employees overtime to ensure that its back orders are taken care of as the goods demanded come in.
Backorder costs are important for companies to track, as the relationship between holding costs of inventory and back order costs will determine whether a company should over- or under-produce. If the carrying cost of inventory is less than back order costs (this is true in most cases), the company should over-produce and keep an inventory.