Book to bill ratio represents the number of orders booked to the amount billed. A book-to-bill ratio is handy when determining a company’s ability to fulfill orders quickly.
In modern business, all kinds of metrics measure how successful a company is. Each metric points to a different performance chart that ultimately points to how well an organization is going. Book-to-bill is one of the more commonly-used metrics in all stages of development.
The metric directly points to how fast companies execute orders. The faster orders are shipped, the higher revenue for the period. We should emphasize that a book-to-bill ratio of orders applies only for a specific period. Once the period finishes, the company will implement additional book-to-bill ratios for the following period.
The metric is most commonly used in the technology industry and subsequent sectors. By analyzing the book-to-bill ratio in a particular technology sector, we can determine the strength of the specific industry.
Investors also use a book-to-bill ratio to determine if the company is worth investing in. A successful or high ratio of orders shipped points to a robust business model with increased customer demand.
How To Calculate the Book-to-Bill Ratio?
Book-to-bill is a standard metric to understand a sector’s or industry’s supply and demand. Companies that operate in more volatile industries can measure the supply and demand for their products by calculating a book-to-bill ratio. Here is the formula.
Book to Bill = Orders Receives / Orders Shipped
A book-to-bill ratio has three outcomes. It can be one, less than one, and greater than one.
If the book-to-bill ratio is one, a company has successfully booked and billed orders for the period. If the ratio is lower than one, it means there is weaker demand for the period. However, if the ratio is greater than one, there is strong demand since the company is receiving more orders than it can bill.
Here are a few examples to help you understand better the book-to-bill ratio.
Example One: Book-To-Bill Ratio Is One
Company A has booked 1000 orders for the period. At the same time, the company has managed to bill all 1000 orders. Using the before-mentioned formula, we can see that 1000/1000 is one. This is the best-case scenario for companies that look for stability, as it means they can successfully meet the supply and demand for their products. However, a book-to-bill ratio of one isn’t the most favorable outcome for businesses.
Example Two: Book-To-Bill Ratio Is Less Than One
Company B has booked 1000 orders, but the number of orders shipped and billed for the period is 1200. This can happen when the company ships and bills outstanding orders from the previous month. In that case, the book-to-bill ratio measures 1000/1200 = 0.83.
This is a strong indicator that there’s more supply than demand for the product. Company B books $0.83 for every $1 billed for the period. A book-to-bill ratio less than one is a declining ratio.
Example Three: Book-To-Bill Ratio Is Greater Than One
Company C has booked 1200 orders for one quarter. However, in the same quarter, the company only managed to ship 1000 orders. Using the book-to-bill formula, we can see that 1200/1000 = 1.2. A book-to-bill ratio greater than one indicates strong demand. This means a company must find ways to start scaling the orders coming. Otherwise, it will fail in supplying the demand for its products.
A company must strive for a book-to-bill ratio of one or very close to the one. Since a book-to-bill ratio greater than one indicates strong demand for its products, it also means the company must find a way to meet the demand with adequate supply.
Conclusion
A book-to-bull ratio is a performance metric that measures a company’s business model. A weak ratio, or ratio less than one, is the worst possible outcome for companies as it indicates greater supply over demand.
Businesses should strive for a book-to-bill ratio of one or greater than one. Both ratios indicate that a company fulfills orders successfully and there’s enough demand for its product.
