Book-to-bill ratio
/What is the Book-to-Bill Ratio?
The book-to-bill ratio compares the amount of new orders obtained to the amount of goods and services billed in a measurement period. When this ratio is expanding (the ratio is greater than 1), it indicates that an organization is able to replace its order backlog with new orders. Conversely, when this ratio is declining (the ratio is less than 1), it is a strong indicator of impending trouble, since a business is now facing the prospect of eventually having no backlog at all, which will lead to a rapid decline in its reported sales.
How to Calculate the Book-to-Bill Ratio
To calculate the book-to-bill ratio, simply compare the monetary value of all new orders obtained during the measurement period to the monetary value of all goods and services sold during the same period. The result is a percentage. For example, a book-to-bill ratio of 89% means that a business has only been able to replace 89% of its latest reporting period’s sales with new orders, while a ratio of 112% means that the business is generating 12% more business than it was able to sell in its latest reporting period.
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How to Use the Book-to-Bill Ratio
The ratio is especially important in industries where customer demand is volatile, since management needs to understand when to start scaling back capacity to meet declining demand levels. The ratio is also used by investors, since a high ratio indicates that an organization has a robust business model that is attracting customers, and so is worthy of investment. Conversely, a declining ratio (especially across a number of reporting periods) is an indicator of possible bankruptcy.
The ratio can also be used as a leading indicator of changes in economic conditions. For example, if the ratio is declining across the automotive industry, this is a strong indicator that the economy is tipping over into a recession. Analysts use this metric to make recommendations to their clients about whether to buy or sell the shares of issuers within targeted industries.
Example of the Book-to-Bill Ratio
A business generates $1 million of new orders in a month, while billing its customers $800,000 in the same period. This results in a book-to-bill ratio of 1.25, which is calculated as follows:
$1,000,000 ÷ $800,000 = 1.25 book-to-bill ratio