Understanding Backorders
A backorder is a term used to describe an order that cannot be fulfilled immediately due to insufficient product availability at the given time.
There are Two Primary Causes for Backorders:
- High demand for the product
- Supply or inventory issues faced by the company
Backorders occur when a company experiences challenges with its supply chain or lacks sufficient storage capacity while also dealing with high product demand.
Another way to describe backorders is when customers place orders for products that are temporarily out of stock but are still being produced by the company.
Backorders indicate a healthy business environment where production outpaces supply.
Companies that handle backorders effectively must have excellent inventory management systems and work diligently to fulfill these orders.
Communication between supply management, inventory management, and the production line is crucial for successfully processing backorders.
How Do Backorders Work?
When a company sells out all available items of a specific product in its inventory but customers still demand it, a backorder is placed.
The sales manager records the request, contacts inventory management, and informs the customer of the expected receipt date.
The inventory manager then initiates production for the back-ordered product.
Customers are kept informed about the progress of their orders, and the time required for final delivery depends on the order’s size and nature.
Backorders also provide insights into a company’s inventory management, demonstrating the efficiency of its processes.
Unique Accounting Approach
Accounting for backorders differs from standard in-stock orders.
The sale of a backorder is recorded as a backorder (or receivable) rather than a completed order.
The sales status changes once the manufacturer delivers the products and receives payment.
This accounting practice is a company safety net; if a customer cancels the order, the accounts remain balanced, and the sale is not disrupted in the books.
How Do Backorders Affect a Business?
Backorders can present both opportunities and risks for a business.
Effectively managing and fulfilling backorders can increase customer satisfaction and loyalty, often resulting in a more extensive customer base than businesses that fail to meet these demands.
Additionally, managing backorders helps save storage costs, as products are manufactured based on actual demand.
The saved costs can be utilized to provide competitive pricing on quality products.
Backorders often indicate the popularity of a product, as customers are willing to wait for its availability. However, a disadvantage is that customers may seek alternative products to avoid the backorder wait.