The book-to-bill ratio is a simple calculation that gives you an indication of how well your business is doing by comparing your income from previous sales with your expected income from new sales within a defined period. In other words, it compares the amount of income from new bookings with the amount billed for that period, hence the name.
This ratio is useful for businesses with a longer lead time on their products or services – in other words, when there is a delay between the point when an order is taken and the point when that order is delivered and payment taken.
How to calculate the book-to-bill ratio
The book-to-bill ratio formula is relatively straightforward. It involves simply dividing the value of bookings for a period by the total income for the same period, as follows:
For the given period:
Value of bookings divided by income from sales = book-to-bill ratio
For example, in Q3 of 2020 you take orders for 15,000 products at $5 each, and in the same period you also receive payments for 10,000 products that had been sold for $5 each. Your book-to-bill ratio for Q3 2020 would be calculated like this:
For Q3 2020:
value of bookings = 15,000 x $5 = $75,000
income from sales = 10,000 x $5 = $50,000
book-to-bill ratio = $75,000 / $50,000 = 1.5
Generally speaking, anything greater than 1 is considered to be a healthy book-to-bill ratio.
How can understanding your book-to-bill ratio help your business?
Understanding your book-to-bill ratio can help you to analyse the performance of your business, and to some extent your industry at large, by comparing the income from orders coming in with that from orders being shipped out. It is useful in industries where supply, demand, or both are highly changeable from one period to the next.
A book-to-bill ratio of less than 1 demonstrates that you may need to take action to increase sales, while a particularly high book-to-bill ratio could suggest that additional resources are required in order to fulfil the orders that are coming in. A high ratio especially could be a sign that sales volumes are likely to continue increasing into the future.
It’s also worth noting that a steady book-to-bill ratio is healthier than one that fluctuates wildly.
Is the book-to-bill ratio useful for all businesses?
As mentioned, a book-to-bill ratio of greater than 1 is considered positive for most businesses. For this reason, the book-to-bill ratio doesn’t provide useful information for companies that receive a payment at the exact moment a sale is confirmed, such as retailers and game developers with in-app purchases. As their orders are placed and paid for at the same time, these businesses would effectively be dividing their sales figure for any given period by itself, meaning their book-to-bill ratio is always exactly 1. Needless to say, these companies won’t gain much insight from their book-to-bill ratios.
Which businesses make use of the book-to-bill ratio?
The book-to-bill ratio applies more commonly to companies that take time to fulfil orders for their products or services once they are placed, which can include manufacturing firms, website developers, marketing agencies and other service providers. Businesses that make use of book-to-bill ratios are often B2B companies, although this is not exclusively the case.
Sometimes investors will also look at a company’s book-to-bill ratio when assessing whether it is worth investing in.
We can help
If you’re interested in improving your understanding of book-to-bill ratios and would like to find out more then get in touch with the financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.