What Is a Backorder?

A backorder is an order for a good or service that cannot be filled at the current time due to a lack of available supply. The item may not be held in the company's available inventory but could still be in production. Or, the company may need to still manufacture more of the product.

The backorder is an indication that demand for a company's product outweighs its supply. They may also be known as the company's backlog.

The nature of the backorder and the number of items on backorder will affect the amount of time it takes before the customer eventually receives the ordered product. The higher the number of items backordered, the higher the demand for the item.

Understanding Backorders

Backorders represent any amount of stock a company's customers have ordered, but have not yet received because it currently isn't available in stock.

Just because they may lack a supply of inventory, that doesn't mean companies can't operate on backorder. In fact, companies can still do business even if they don't have inventory on the books. Keeping products on backorder helps boost demand, retain and increase the customer base, and creates value for their products.

A company's backorders are an important factor in its inventory management analysis. The number of items on backorder and how long it takes to fulfill these customer orders can provide insight into how well the company manages its inventory. A relatively manageable number of orders and there a short turnaround time to fulfill orders generally means the company is performing well. On the other hand, longer wait times and large backorders may be problematic.

Apple had to put its iPhone X backorder just after its release in 2017. Even though the initial supply of the phone sold out, demand remained high. According to the Financial Times, customers whose orders were on hold were told their wait time for delivery was roughly four weeks.

How to Account for Backorders

Backorders or a company's backlog may be expressed as a dollar figure—as in the value of sales—or by the number of units ordered and/or sold.

Backorders often require special accounting. Companies normally inform customers that the product they've ordered is on backorder when the order is placed, and when delivery is expected.

Companies should keep in contact with customers when there is a problem with fulfilling their backorders as promised to ensure orders aren't canceled.

The sale is then recorded on the company's books as a backorder rather than a completed sale. If the customer decides to cancel the order, this doesn't affect the company's bottom line, and it won't have to reconcile its accounting records. The company will then place the order with its manufacturer to deliver the goods. Once the shipment is received, the company will then search for the purchase order and follow through with the delivery. The sale can be recorded and then checked off as complete.

Key Takeaways

  • A backorder is an order for a good or service that cannot be filled immediately because of a lack of available supply. 
  • Backorders give insight into a company's inventory management. A manageable backorder with a short turnaround is a net positive, but a large backorder with longer wait times can be problematic.
  • Companies with manageable backorders tend to have high demand, while those that can't keep up may lose customers.

Advantages of Backorders

The term backorder may conjure up negative images, but there can be positives to businesses that have these orders on the books.

Keeping a large supply of stock requires storage space, which, in turn, requires money. Companies that don't have their own storage centers have to pay for services to hold their inventory. By keeping a small amount of stock in supply and the rest on backorder alleviates the need for excess/extra storage, and therefore, reduces costs. This cost reduction can be passed on to consumers, who will likely return because of a company's low prices. This is especially true when sales and demand for certain products is high.

Problems with Backorders

If a company consistently sees items in backorder, this could be taken as a signal that the company's operations are far too lean. It may also mean the company is losing out on business by not providing the products demanded by its customers. If a customer sees products on backorder—and notices this frequently—they may decide to cancel orders, forcing the company to issue refunds and readjust their books.

When an item is on backorder, a customer may look elsewhere for a substitute product, especially if the expected wait time until the product becomes available is long. This can provide an opportunity for once loyal customers to try other companies' products and potentially switch their loyalties. Difficulties with proper inventory management can lead to the eventual loss of market share as customers become frustrated with the company's lack of product availability.