Book to Bill RatioDefined along with Formula & How to Calculate

Generating profits is the primary purpose of starting and eventually running a business.

And to make the business sustainable, it should be able to consistently generate profits from year to year.

Even better if the amount is increasing, it means that the business is doing well and growing.

One way to gauge a business’s sustainability and growth is to measure customer demand.

Is the customer demand growing?

Is it in status quo?

Or is it declining?

Aside from that, we can also look at the ability of the business to meet customer demand.

Is the business able to produce enough products or provide enough services to meet the customer demand?

To answer the above questions, we can rely on certain tools, one of which is the book-to-bill ratio.

In this article, we will be learning about the book-to-bill ratio.

What is its definition?

How does one calculate it?

How does it apply to your business?

What information does it tell us?

Read on to find out.

What is the Book-to-Bill Ratio?

The book-to-bill ratio is a metric that compares a business’s amount of new orders booked to its amount of goods and/or services completed and billed for a certain period.

Hence, book-to-bill.

In general, the measurement period is a month or quarter.

It is an especially useful ratio for industries where customer demand is volatile, such as the technology industry.

The book-to-bill ratio not only tells how well an individual business is doing, but it can also tell us about the strength of an entire industry.

For potential investors, the book-to-bill ratio is a useful indicator of a business’s performance, as well as sustainability.

Basically, if a business has equal or more bookings than billings, it means that customer demand is high.

This ultimately means that the business is profitable.

On the other hand, it customer demand is on a constant decline over several periods, it may mean the business is declining unless something is done about it.

In general, investors would want to invest in a business that still has the potential to grow.

The book-to-bill ratio can help in assessing that.

For analysts, the book-to-bill ratio is an indicator of a business or an industry’s strength.

As long as demand (bookings) is equal to or more than supply (billings), the business or industry is profitable and sustainable.

Book-to-Bill Ratio Formula

The calculation for the book-to-bill ratio is simple.

We only need to divide the value of bookings by the value of completed orders billed.

Do note that both variables must be of the same period.

For example, if we were to use the value of bookings for January, we should use the value of billings for the same month.

Put into formula form, it should look like this:

Book-to-Bill Ratio = Value of Bookings ÷ Value of Billings

-or-

Book-to-Bill Ratio = Value of Orders Received ÷ Value of Completed Orders Billed

To further understand the formula, let’s use an example.

Let’s say that in January, the AA company has a total of new billings amounting to $350,000.

Meanwhile, it has completed and billed orders amounting to $280,000.

Let’s compute AA company’s book-to-bill ratio for January:

Book-to-Bill Ratio = Value of Bookings ÷ Value of Billings

= $350,000 ÷ $280,000

= 1.25

As per computation, AA company’s book-to-bill ratio is 1.25.

What does this mean for the AA company though?

What does the Book-to-Bill Ratio Tell Us?

The book-to-bill can help us in analyzing the performance of a business (or an entire industry).

Depending on what the ratio is, we can assess the relationship between demand and supply.

If the book-to-bill ratio is exactly 1, it means that the business can fulfill orders at the same time or period that they are received.

For example, if the value of new orders for January is $300,000 and the value of orders completed and billed is $300,000, then the book-to-bill ratio is 1.

This is the expected book-to-bill ratio for businesses where orders are immediately fulfilled the same day they are made such as retail stores or same-day services.

If the book-to-bill ratio is more than 1, such as in the AA company example we have above, it could mean two things.

It could mean that the business is expanding, where order backlogs are replaced with more new orders.

Or it could mean the other way where the level of operations is declining.

Ideally, you want a situation where customer demand is increasing as it leads to more profits.

To make sure if such is the case, you can compare the previous period‘s value of orders completed and billed to the current period.

If the former is less than the latter, then that’s good news.

But if it’s the other way around, the business will have to reassess its operations and identify why it went down.

If the book-to-bill ratio is less than 1, it means that demand is either declining, or the business is clearing more of its backlog than receiving new orders.

None of these scenarios is ideal.

Essentially, both scenarios lead to the same outcome: a shrinking customer demand, which eventually leads to fewer profits.

Generally, a steady book-to-bill ratio is preferable to one that fluctuates unpredictably.

How Understanding the Book-to-Bill Ratio Helps a Business

Understanding your business’s book-to-bill ratio help you plan your level of operations.

If the book-to-bill ratio is more than one, it may mean that you have to increase the level of operations so that you can fulfill the influx of new orders.

On the other hand, if the book-to-bill ratio is less than one, you can do two things depending on the situation.

If the low book-to-bill ratio is caused by an overall reduced demand within the industry (e.g. due to recession), you may want to decrease the level of operations so that there is no surplus of supplies.

You don’t want to have goods that you can’t sell after all.

The other scenario is when you can do something about the value of bookings or new orders.

If you can increase customer demand through clever marketing strategies, then you should do so.

Is The Book-to-Bill Ratio Useful for Any Type of Business?

Unfortunately, the book-to-bill ratio isn’t uniformly helpful across the different businesses and industries.

It isn’t as useful for businesses where orders are fulfilled within the same day or period that they are made.

A prime example of this is a retail store or a convenience store.

The order is fulfilled at the same time the customer pays for his/her product.

The book-to-bill ratio for this type of business is expected to be always 1.

As such, it won’t tell much about the business’s performance, just that the business fulfills orders as it receives them.

Instead, the book-to-bill is more useful to businesses where it takes time to fulfill an order.

It could be because the whole manufacturing process takes months, or that the term of service is always lengthy.

For example, website development.

Developing a website, or at least a good one, isn’t doable in a day.

It takes several weeks or even months.

The book-to-bill ratio is also important for businesses or industries where customer demand is volatile.

This is especially if customer demand isn’t something that business or industry can directly influence.

The book-to-bill ratio can help such businesses in planning their level of production.

If the book-to-bill ratio is on a constant rise, then it is an indicator that the business must increase its level of production.

On the other hand, if the book-to-bill ratio is on a constant decline, it may indicate the business to scale down its operations to meet the declining demand.