The book-to-bill ratio compares the aggregate 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 sales. For example, 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
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.