New businesses that generate recurring monthly income use the Rule of 78 to estimate how much revenue they will have by the end of the full calendar year. It sets a healthy monthly target for each salesperson to ensure that the company achieves its financial goals.
This article will describe what the Rule of 78 in sales is, how to calculate it, and why it’s crucial for companies eying sustainable, long-term growth.
What is the Rule of 78?
The Rule of 78 in sales is commonly used when computing a business’ monthly and annual sales quotas. Most companies that want to ramp up their revenues and surpass the previous calendar year’s income use the Rule of 78 to determine how much money will come in by the end of the year.
It also gives business owners an idea of how much the monthly recurring income should increase in the next succeeding years to meet continuous sales growth.
Who uses the Rule of 78?
Companies that offer subscription-based services or products such as maintenance medicine, utilities, cloud-based accounting software, marketing and advertising, entertainment, and third-party IT management, use the Rule of 78 to determine their sales forecast at the end of the calendar year. This provides a good measure how much each sales representative should bring in every month to maintain steady growth.
Understanding the concept behind Rule of 78 in Sales
Assuming that the business generates $1 in January from one paying customer, the assumption is that the business will generate the same $1 of recurring sales income for the next 11 months.
If the business generates another $1 of new revenue in February from another paying customer, the assumption is that this money will be in the accounts for the remaining 10 months, and so on.
This concept applies well to subscription-based services and other revenues that are recurring monthly. Keep in mind that every new dollar earned by the company on a monthly basis will be in the accounts for the rest of the year, even if a new customer comes.
That said, an income of $1 in January will be worth $1×12 = $12 for the the whole year; an income of another $1 in February will be worth $1x$11 = $11, and so on. Adding the total monthly revenues will bring the business $78 by the end of the year, assuming that the business generates the same revenues each month.
We provided a simple table to demonstrate the concept behind Rule of 78. The table below assumes that one new customer is acquired every month, for 12 months.
What is the Rule of 78 calculation?
When applying the Rule of 78 in sales, the formula is as simple as multiplying the target monthly income by 78 to estimate the total annual revenue. This assumes that the company only brings in one customer per month and pays the same amount for every transaction.
For example, if the monthly sales quota is set at $10,000 per month, this means that each sales person is expected to deliver $10,000×78 = $780,000 annually. If the business owner provides a high-ticket number of $1,000,000 worth of gross revenues, then simply divide it by 78 to get the monthly sales revenue goal of $12,820.
How the Rule of 78 benefits the business
Most new businesses that charge a monthly recurring fee use the Rule of 78 to achieve financial stability and expand their business – whether it’s to set up a new branch or hire new talent to create new products or services. The Rule of 78 provides an informed estimate of how much the business should achieve monthly in terms of sales to meet its goals, mitigate risks, and serve customers better.
Supposing that the company eyes to achieve $200,000 in gross sales for the year, using the Rule of 78 formula will allow managers to set a $2,564 target in recurring sales per month to keep the business afloat.
This means that if the sales department currently has four representatives, each of them should bring $641 of recurring sales in January and generate another $641 in February on top of the revenues collected in the previous month.
Applying the Rule of 78 will allow business owners to lay the groundwork for the next phase of their growth strategy, address any process bottlenecks, and provide value to loyal customers to avoid cancellations of their subscription.
While the Rule of 78 perfectly fits subscription-based products or services or any other initiative that generates recurring monthly income, companies shouldn’t discount the fact that non-recurring sales also help ramp up revenues.
Almost all types of businesses offer products that customers can purchase at a one-time basis like real estate or on-premise accounting software, so managers need to balance all of its revenue sources before applying the Rule.
Rule of 78 in loans
Salespeople are not the only ones who take advantage of the Rule of 78. In fact, lenders use the Rule to calculate interest charges on a loan. The Rule of 78 in loans requires the borrower to pay higher interest charges in the first half of the loan cycle, and decreases later on.
The Rule of 78 in loans mostly benefits the loan provider since it decreases the borrower’s potential savings for paying off the debt in a shorter period of time. This is often used by lenders who offer short-term loans to subprime borrowers or those who pose higher risks in the eyes of creditors.
Planning to use the Rule of 78 in 2021?
Some small business owners who have been greatly affected by the COVID-19 pandemic may have pivoted to a subscription-based approach to ensure sustainability in terms of growth and security in terms of customers. Using the Rule of 78 will help these growing enterprises to easily forecast and track recurring streams of income so they can make strategic sales decisions for the next fiscal year.