Use “The Rule of 78’s” to Quickly Calculate Recurring Revenue

Much of the software industry has moved to Software as a Service (SaaS) or a cloud model. It’s great, especially for small/medium businesses, because the pricing model delivers more predictable, smoother revenues. When you take an order, you may call it Monthly Recurring Revenue (“MRR”), Monthly Recurring Charge, Recurring Monthly Revenue, etc. I’ve found that a concept called the “Rule of 78’s” is convenient for back of napkin thinking or a quick understanding of pricing models, quota setting and other sales/revenue management calculations.

The Rule of 78’s, also known as the Sum of the Digits method, is a financial concept that refers to a method of yearly interest calculation.  In my opinion, the method is intended to stick it to consumers who pay off a loan early.  According to Wikipedia, a bill was introduced in the US Congress in 2001 to stop the practice of using the rule for consumer credit transactions. The bill was referred to the Subcommittee on Financial Institutions and Consumer Credit where it “died without further comment”.

Another use of the rule is to calculate the sum of a recurring revenue stream in a zero-based plan.

Rule of 78sSay for instance your sales plan calls for you to sell one new MRR contract each month during a year. Each contract will be for $1,000 per month.  For January, you’d earn $1,000. In February you’d get the $1,000 from the deal you did in January, PLUS an additional $1,000 from your deal in  January.  This goes on through the year and you collect $12,000 just during the month of December.

Add all the revenue you earn during the year by selling $1,000 of new recurring revenue each month and the total is $78,000. Hence, the Rule of 78’s.

For example, if your plan called for you to sell $4,000 in new MRR orders each month, you simply multiply $4,000 times 78 to get $312,000. This is the total amount you’d earn during the period from your new orders.  Obviously, the Rule of 78’s only works on a zero-basis and only for a 12 cycle recurrence.  (I hereby invent “the Rule of 300” for periods of 24).

It’s a simple method you can use for quickly understanding quota allocation, headcount planning and in other instances where you’re working with recurring revenue.

It’s also possible you could get an appreciative nod from your CFO when you roll out the rule during annual planning.

 

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