For companies, calculating and analyzing metrics provides meaningful information about various aspects. Companies use metrics to measure their performance in various fields. Similarly, these metrics help them determine how they are doing compared to historical information or other companies. The use of these tools differs from one company to another. Similarly, over time the requirements will change.
Financial metrics are also significantly crucial for stakeholders. These metrics usually come in the form of financial ratios, which require values from financial statements. Using these ratios, stakeholders can analyze various aspects of a company’s operations. The data needed to compile these ratios usually comes from the balance sheet and income statement. Some may also come from the cash flow statement.
What Are The Types of Financial Ratios?
There are several types of financial ratios that evaluate different aspects of a company’s operations. These include liquidity ratios, leverage ratios, efficiency ratios, market value ratios, and profitability ratios. A description of each of these ratios is as below.
Liquidity ratios
Liquidity ratios are a type of financial ratio that measures a company’s ability to repay short- and long-term obligations. These primarily consider a company’s working capital and how it holds against other companies. Liquidity ratios help analyze a company’s liquidity position. Some critical liquidity ratios include the current, cash, quick, and operating cash flow ratios.
Leverage ratios
Leverage ratios focus on a company’s debt position. These ratios help stakeholders analyze how many debts a company has accumulated. Debt finance is crucial for companies, but it may have some drawbacks. For stakeholders, it is vital to understand how much leverage a company has. Therefore, they use leverage ratios to evaluate it. Some leverage ratios include debt ratio, debt-to-equity ratio, debt service coverage ratio, and interest coverage ratio.
Efficiency ratio
Efficiency ratios measure if a company is efficiently utilizing its resources. Also known as activity ratios, these metrics allow stakeholders to understand a company’s operations. Usually, these involve assessing how a company uses its available resources to generate sales. Some of the prominent efficiency ratios include the asset turnover ratio, inventory turnover ratio, receivable days, inventory days, etc.
Profitability ratios
Profitability ratios are one of the most prominent metrics to evaluate a company’s financial performance. These ratios measure a company’s ability to generate income relative to its assets, revenues, equity or operating costs. Similarly, they consider how efficiently a company converts its resources into profits. Some profitability ratios include gross margin ratio, operating margin ratio, return on assets and return on equity.
Market value ratios
Market value ratios include metrics that help assess a company’s share price. They are critical for stakeholders who want to evaluate a company. Usually, investors can obtain a company’s book value from its financial statements.
However, the market value may be a better indicator of its current value. Market value ratios include the book value per share, dividend yield ratio, earnings per share ratio, price-earnings ratio, etc.
What Is The Book-to-Bill Ratio?
The book-to-bill ratio describes the relationship between a company’s total orders received and total orders shipped. Usually, it only considers a specific period which is a month or a quarter. The book-to-bill ratio helps companies determine the efficiency of meeting their orders. Similarly, it provides insights into how long it takes for companies to complete their orders.
The book-to-bill ratio is highly critical in the technology industry. However, it also has its application in other sectors. This ratio is also crucial for investors and analysts. These parties use the book-to-bill ratio to determine a company’s performance. Similarly, they use it as an outlook for individual companies and the industries in which they operate.
The book-to-bill ratio is an indicator of how well a company is doing. It reveals how quickly a business fulfills the demand for its products. It can also indicate whether a company lags when it comes to meeting the orders received. Similarly, it may reveal if a company can meet the demand efficiently. Investors and analysts can also use it to compare the performance of different companies.
Overall, the book-to-bill ratio is a significant metric in determining a company’s efficiency in meeting demand. Regardless of how many orders companies receive or their size, this ratio provides a comparable figure. Therefore, investors can easily compare it with other companies to get meaningful results. Before understanding that, however, it is crucial to know how to calculate it.
How to Calculate The Book-to-Bill Ratio?
The book-to-bill ratio requires companies to obtain their orders received and shipped figures. Usually, this information is only available from management reports. Once they do so, they can calculate the book-to-bill ratio using the formula below.
Book-to-Bill Ratio = Orders Received / Orders Shipped
However, that poses a problem to stakeholders. Usually, they don’t have the required information to calculate a company’s book-to-bill ratio. Therefore, there is an alternative book-to-bill ratio formula that can help them as below.
Book-to-Bill Ratio = Value of Bookings / Income from Sales
Both of these formulas for the book-to-bill ratio will return the same result. However, the above formula makes it accessible to stakeholders who want to calculate it without having access to management reports. The information for the above formula is usually available from a company’s financial statements.
How To Interpret the Book-to-Bill Ratio?
The book-to-bill ratio presents the relation between a company’s orders received and completed orders. Usually, companies and stakeholders prefer for this ratio to be greater than 1. It signifies that the company is healthy with a backlog of new orders. However, if it is lower, it can indicate problems for the company. Usually, a book-to-bill ratio of less than 1 represents a higher supply than demand for companies.
If the book-to-bill ratio is exactly 1, it means the company received the same number of orders that it shipped. In practice, however, this ratio is rarely level for larger companies. The difference between orders shipped and orders received always creates a fluctuation in the book-to-bill ratio. For companies and stakeholders, these fluctuations are highly critical.
Example
A company, ABC Co., manufactures and sells televisions. The company received orders of 9,850 units during the month of June. However, ABC Co. shipped 10,000 televisions to customers during the month. Therefore, the company’s book-to-bill ratio will be as follows.
Book-to-Bill Ratio = Orders Received / Orders Shipped
Book-to-Bill Ratio = 9,850 units / 10,000 units
Book-to-Bill Ratio = 0.985
The above ratio signifies that ABC Co. did not complete all of its orders. However, the ratio was close to 1, which means the company was efficient enough in meeting the demand. The difference between the orders received and orders shipped might arise from various reasons. Nonetheless, the company was close to meeting all the orders.
What Is The Importance of the Book-to-Bill Ratio?
The book-to-bill ratio is important for various reasons. For industries where customer demand is volatile, this ratio helps companies learn how to run their operations smoothly. They can use it to understand when to scale up their operations and cut down on the supply. The book-to-bill ratio can also indicate financial problems for companies if it is constantly below 1.
For investors, the book-to-bill ratio is also significantly critical for the same reasons. Investors track this ratio to understand how well a company is doing. If this ratio is above 1, it means the company is healthy and attracting new orders. It also indicates the company’s salesforce is efficient in generating new orders. For these reasons, the book-to-bill ratio is critical for both companies and their stakeholders.
Conclusion
Financial ratios help evaluate various aspects of a company’s operations. The book-to-bill ratio is the relation between a company’s orders received and dispatched. Usually, stakeholders prefer for this ratio to be higher than 1. The book-to-bill ratio is significantly important for various reasons, as listed above.
