What it means
When demand exceeds available stock, a business has three choices: turn the customer away, substitute another product, or take the order and fulfil it later. The third is a back order.
It preserves the sale and the relationship, at the cost of a delay the customer may not tolerate, and it creates an obligation the business must track and honour. Some back orders are inevitable in any business that carries stock; a high or persistent level means forecasting, purchasing or supplier performance is failing.
From an accounting perspective, a back order is not a transaction until it ships. It does not appear in revenue, receivables or inventory; at most it is disclosed as part of an order book.
If the customer has paid in advance, the payment is deferred revenue until delivery. This is why back-order levels are an operational metric rather than a financial one, though they have financial consequences: delayed revenue, expediting costs, and the lost sales that occur when customers cancel or go elsewhere.
Operationally, back orders need active management. Each one should carry an expected fulfilment date, the customer should be told that date and kept informed, and the purchasing team should see the back-order list as a priority signal for what to expedite.
Businesses track back orders as a percentage of orders, the average days to fulfil them, the cancellation rate while on back order, and the value of the back-order book. A rising book with a lengthening fulfilment time is an early sign of supply problems; a book that is cleared quickly is a sign the process works.
Back orders are also a strategic choice about inventory. Holding enough stock to eliminate them costs money in carrying costs and obsolescence risk; running lean and back-ordering costs money in lost sales and service.
The right balance depends on the margin, the customer's willingness to wait, and the competitive alternatives. A specialist parts supplier can back-order freely because customers have no alternative; a fashion retailer cannot, because the customer buys elsewhere within minutes.
In practice
Real-world examples.
Example
A furniture retailer takes orders for a popular sofa with a six-week back order, collects a deposit recorded as deferred revenue, and recognises the sale when the sofa is delivered.
Example
A spare parts supplier back-orders an obsolete component from a specialist manufacturer and the customer waits eight weeks because no alternative exists.
Example
An online electronics store shows "back order, ships in 3 to 5 days" on product pages rather than "out of stock", and finds that 70% of customers still place the order.
Think of it
“A back order is an order you can't fill yet because you're out of stock-demand waiting for supply.
Formula
Calculation
Back Order Rate = Orders (or order lines) placed on back order / Total orders (or lines) x 100%
Average Back Order Duration = Sum of days each back order remained open / Number of back orders fulfilled
Back Order Cancellation Rate = Back orders cancelled by customers / Total back orders x 100%
Cost of Back Orders = Cancelled back-order value x Gross Margin + Expediting costs + Administrative cost per back order x Number of back orders
Worked example. An industrial supplies distributor processed 40,000 order lines in a month, of which 2,800 could not be filled from stock and were placed on back order.
- Back order rate = 2,800 / 40,000 = 7.0%
Of the 2,800 back-ordered lines: 2,300 were fulfilled at an average of 11 days; 500 were cancelled by customers, with an average value of $180 per line.
- Cancellation rate = 500 / 2,800 = 17.9%
- Lost revenue = 500 x $180 = $90,000; at a 30% gross margin, lost gross profit = $27,000
- Expediting costs (air freight, supplier surcharges) for the month = $14,000
- Administrative cost of managing back orders (customer updates, re-picking, second delivery) estimated at $12 per line x 2,800 = $33,600
- Total monthly cost of back orders = $27,000 + $14,000 + $33,600 = $74,600, or about $895,000 a year
Analysis shows 60% of the back-ordered lines come from 150 products (out of 12,000) whose reorder points were set on outdated demand data. Raising safety stock on those 150 lines would add about $200,000 of inventory at a carrying cost of roughly $40,000 a year, against a likely reduction in back-order costs of $500,000 or more. The distributor raises the reorder points.Case study
Seen in the real world.
A bicycle components distributor prided itself on lean inventory and a back-order rate that had risen from 3% to 12% over two years without anyone treating it as a problem; the orders were still on the books, after all. A new operations director analysed the back-order log and found that 28% of back-ordered lines were eventually cancelled, that customers who experienced a back order placed 40% fewer orders in the following six months than those who did not, and that the customer service team spent a third of its time answering "where is my order". The true cost, including the lost future orders, was estimated at over $1 million a year against inventory carrying costs of $300,000 that the lean policy had saved.
The company rebuilt its reorder points from twelve months of actual demand, added safety stock on its 400 fastest-moving lines, and set a target back-order rate of 3%. Within six months the rate was 3.5%, customer service time on order chasing fell by two thirds, and repeat order frequency recovered.
Watch out
Common mistakes.
- Treating a back order as a sale. It is an unfilled commitment; revenue comes only on delivery, and a share of back orders will never be fulfilled.
- Measuring the back-order rate without the cancellation rate and the effect on future orders. The visible cost is a fraction of the total.
- Leaving customers uninformed. A back order with a clear date and updates is tolerated; one with silence is cancelled.
Questions
People also ask.
What is the difference between a back order and a stockout?
A stockout is the condition of having no stock. A back order is what happens when the business accepts an order despite the stockout and fulfils it later.
Should back orders be recognised as revenue?
No. Revenue is recognised when the goods are delivered. Advance payments for back-ordered goods are deferred revenue.
What is an acceptable back-order rate?
It varies by industry and product, but most distributors aim below 2% to 5% of order lines, with faster fulfilment and lower cancellation as the more important measures.
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