Last editedMay 20212 min read
In sales and finance, Rule of 78 is a formula used to estimate the annual revenue of a business that charges monthly fees. It’s easy to assume that you can estimate your yearly revenue by multiplying monthly earnings by 12 – but if your business uses a subscription-based model, things can become complicated.
Through the Rule of 78, recurring revenue is more accurately accounted for.
What is the Rule of 78 used for?
In order to help guide your business strategy and approach going forward, you need to be able accurately estimate your financial performance. Estimating your sales revenue will help define short-term goals, informing you how much you need to earn each month in order to reach your year-end target.
It becomes a little more complicated to estimate and calculate revenue when you have multiple revenue streams, and especially when you offer monthly recurring billing options to your customers. The Rule of 78 is designed to help businesses who charge recurring fees to estimate earnings.
The Rule of 78 is a also valuable formula for small businesses targeting expansion, telling you just how viable growth is based on current performance and projections.
Simply put, the Rule of 78 determines how much a business needs to make in recurring sales every month in order to remain financially stable.
The methodology assumes that a new customer acquired will continue to make recurring payments throughout the year. For example, a customer who joins in January will make 12 payments of equal value throughout the year. A customer who joins in February will make 11 payments, a customer joining in March will make 10, and so on. 78 is the total sum of payments that would be made if a new customer joined every month (12+11+10+9, etc.).
Rule of 78 formula
The Rule of 78 formula is simple.
Just multiply the amount of new revenue you expect to bring in each month by 78 to get your yearly sales forecast. A caveat to the Rule of 78 formula is that it assumes you’ll gain just one new customer per month – and that every customer is paying the same monthly fee. The estimate will therefore be inaccurate if you don’t end up bringing new customers in every month. Assuming you will bring in new customers, the Rule of 78 can be used to estimate the minimum revenue you might earn in the year.
The Rule of 78 is commonly used with sales quotas. If you have a set sales quota that must be met each month, you can multiply it by 78 to see how much each salesperson will bring in over the year. For example, with a sales quota of $2,000 per month, you can expect each salesperson to bring in $156,000 in a calendar year.
You could also use the Rule of 78 calculator in reverse. If you have a target revenue and you want to work out how much needs to be earned each month, simply divide your target revenue by 78. So, if you know you want to make $1,000,000 by the end of the year, divide one million by 78, and you’ll see that you need to earn roughly $12,821 each month. You can then divide this figure across your sales team to set monthly targets for each salesperson.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.