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

Understanding Backorders

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 back ordered, the higher the demand for the item. 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 a short turnaround time to fulfill orders generally mean the company is performing well. On the other hand, longer wait times and large backorders may be problematic.

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. 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.

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 true when sales and demand for certain products is high, especially for new releases of highly popular goods. Backorders also garner attention, and some may be enticed to know more about items that have sold out. Although this may conjure negative connotations to some, others will approach backordered goods as a good thing. Backordered goods are popular, in high demand, difficult to get, and may appear as a status symbol.

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. Backorders may require additional resources in managing pre-orders or clients that are waiting for their product. Instead of simply carrying inventory and selling it to customers, a company must incorporate receiving orders, managing obligations, coordinating logistics, and communicating to specific customers when their product is ready. The company may also require heavier use of public communication to monitor the situation and further inform the product's availability.

Example of Backorder

When Apple, Inc. releases new products, they're often met with exuberant demand around the world. Early adopters often want to get their hands on the latest technology, and many users plan on upgrading their old technology for the newer product.

According to Apple's website, shipments will be sent when the items of order become available. Popular items that are not in stock will be noted with longer timeframes indicated on online orders. Some products may also not be eligible for deliveries with pre-selected time windows.

This is truly a natural part of Apple's business. In the company's 10-K, Apple mentions that "disruptions in the Company's supply chain and sales and distribution channels, resulting in interruptions of the supply of current products and delays in production ramps of new products."