What is a Back Order?

A back order is a customer order which the supplier cannot currently ship, but expects to ship at a later date. The proportion of customer orders that are on back order is a common customer service metric. Another related metric is the average number of days that a customer must wait before back orders can be filled.

A more refined form of the back order is to only identify an undelivered item as a back order if a customer agrees to wait for the late delivery. If not, the back order is cancelled.

Back orders are heavily influenced by the inventory stocking policies of a business. For example, if management elects to maintain large stocks of all items offered for sale, then the probability of a stockout condition is low, and there will be few back orders. However, this requires a major investment in inventory, and may result in write-offs related to obsolete goods. The reverse situation is to stock minimal amounts of inventory and rely upon customers to wait while back ordered items are acquired elsewhere or produced in-house.

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Accounting for Back Orders

When a customer places an order that is placed on backorder, any payment made by the customer is recorded by the seller as a liability. Once the backordered item has been delivered to the customer, the liability is debited (to clear it from the books), and a credit is used to record a sale. If customers make no cash payments up-front, then there is no accounting transaction to record. Instead, the backorder is recorded within the firm’s order entry system, which is not related to the accounting system.

Advantages of Back Orders

There are several advantages to having back orders, which are as follows:

Reduced inventory investment. The main advantage of back orders is that they allow a business to invest less in inventory. Instead, they wait for customer orders to arrive, take their money, and then produce the goods. The result is a low working capital investment in the business, which makes it easier to operate with a minimal investment.
Lower prices. Since the presence of back orders reduces the inventory investment and holding costs of a business, this means that the firm could pass these savings through to its customers. Doing so will attract customers who like low prices, and who do not mind waiting a while to obtain the ordered items. This approach can be especially effective when customer demand is high.

Having a low back order percentage can be a competitive advantage. A business could use a variety of inventory management techniques to fill a high percentage of its orders within a short period of time, and then market its order fulfillment rate to customers. If customers want to have their orders filled at once, then they will be more likely to place orders with a firm that reports a low back order rate.

Disadvantages of Back Orders

There are several negative issues associated with back orders, which are as follows:

Lost sales. A key problem with backorders is that a business is losing sales to its competitors. This happens because customers are not willing to wait for the firm to deliver backordered goods to them.
Lost customers. Repeated backorders can result in the permanent loss of customer loyalty, who never return to the organization to place orders. This is a particular concern when customer loyalty is not strong; instead, they had previously only been placing repeat orders out of habit. If a competitor can provide better products or service, then customers will leave.