Posted by: Mike Clough

Managing By Rules of Thumb

rule of thumbMost small business owners and entrepreneurs find themselves overwhelmed with duties ranging from janitor to Chief Executive Officer. With so many duties to perform, small business owners do not have the time to study reams of financial reports in order to effectively manage their business. What I have learned through the years is that I can manage a lot more efficiently and effectively if I manage by “rules of thumb”.

Wikipedia defines rule of thumb as “a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination.”

So why would it make sense to manage by a method that “is not intended to be strictly accurate or reliable for every situation”? Well, because it is easily learned, easy to remember and easy to apply. Having certain financial “rules of thumb” can help you identify problems in your business very quickly and show you where you need to focus your attention. Then, you can drill down into the financial reports to pin point where the problem lies and which issues need to be addressed.

One of the major benefits of using a really good accountant is the enormous amount of information they can give you. This is why I always tried to hire the very best. There was a time when, each month, my director of finance would hand me 150-200 pages of numbers in very neat rows and columns. At first, I spent a lot of time studying these numbers so I could manage better. However, I quickly realized that as good as she was, and what she was giving me, as valuable as it was, was totally overwhelming and there was information I needed that was missing. For example, how do these numbers compare to the budget and business plan we created prior to the first of the year?

So, we got together and created a two to three page “Key Factors Report” that took key numbers from the standard reports, converted them to ratios and “rules of thumb”, and then compared them to the budget, month-to-date and year-to-date. It took no time to review these reports. If something was out of line, I saw it immediately rather than having to dig through hundreds of pages to find it. Once an issue was identified, I could then drill down to that area of the report to understand why it was out of line. As a result, I was able to manage more effectively, respond to problems earlier, resolve issues quicker, and move on.

What inspired me to write this article was a website I recently stumbled upon; Rules of Thumb. It lists thousands of rules of thumb. Some are old and may not apply as well as some of the others. Nonetheless, I found them entertaining and would like to share a few with you:

  • SELLING A BUSINESS
    The sale price of a small business is between seven and ten times the average profit of the last three years.
  • MAKING YOUR IDEAS CLEAR
    A clear idea is one that fits on the back of a business card.
  • GETTING WORK DONE
    People do best when they’re working at 80 percent of their capacity. At 50 percent, they get bored. At 100 percent, stress gets them.
  • CHOOSING A BIDDER
    Throw out the highest and lowest bids. Average the rest and choose the one closest to the average.
  • STARTING A NEW BUSINESS
    Do not start a new business unless you can wait at least one year before realizing a profit.
  • THE 80/20/30 RULE
    If you get rid of the 20 percent of your customers who cause 80 percent of your headaches, your profit will increase by 30 percent.
  • CONSULTING
    A consultant should spend two-thirds of his or her time consulting with clients and one-third lining up new work and doing PR.
  • KEEPING YOUR CUSTOMERS
    Complainers are more likely than dissatisfied non-complainers to do business again with the company that upset them, even if the problem is not satisfactorily resolved.
  • KEEPING YOUR CUSTOMERS
    Between 54 percent and 70 percent of customers who complain to a company will do business again with the company if their complaint is resolved. That figure increases to 95 percent if the customer feels the complaint was resolved quickly.
  • KEEPING YOUR CUSTOMERS
    The average customer who has had a problem with a company tells nine or ten people about it.
  • KEEPING YOUR CUSTOMERS
    Customers who have complained to a company and who had their complaint satisfactorily resolved tell an average of five people about it.
  • WORKING WITH A NEW CLIENT
    A job with a new client will take about 25 percent longer than the same job with an established client.
  • BALANCING THE BOOKS
    When the books aren’t balancing, if the amount they are out of balance is divisible by 9 then there is a transposition error in your figures.
  • STAFF MANAGEMENT
    If you have to call a meeting to tell everyone that you have an open-door policy, you have already failed as a manager.
  • GETTING PAID
    When dealing with notorious non-payers, always charge twice as much as the job will actually cost, then get half the money up front.

Okay, you got me. These were not the rules of thumb that made such a big difference in how I managed my businesses. Still, I enjoyed reading them and wanted to share them with you because some of them are quite practical.

The rules of thumb that I am talking about are unique to your business and can only be determined by building a thorough budget/business plan. As I mentioned earlier, you need to think in terms of key factor ratios. Why ratios? Allow me to explain.

Let’s look at marketing expenses as an example. When you budgeted for this expense, the total was probably based upon some variables like commissions (which will be more or less, based upon what is actually sold), and some fixed costs like signage (which will be the same regardless of the actual amount of sales). If there is a substantial amount of fixed costs, marketing becomes more efficient as sales grow. Therefore, a good ratio or rule of thumb to monitor would be “marketing expense as a percentage of revenue.”

Assuming you have created a realistic budget that produces the desired results, how does your actual ratio compare to the budged ratio? If it is as expected or better, there is no need to spend a lot of time drilling down to each line item. If results are not as expected, or worse, then this is another story and you can drill down to the appropriate line items to figure out what went wrong. It’s not that important if you went over budget in marketing expenses if the ratio is as expected or better.

You will be surprised at the amount of great information you can put on just two to three pages if it is limited to key factors (totals) and various important ratios and rules of thumb that apply to your business. However, I have found one major problem in utilizing this system when I counsel with many small business owners. They don’t have a budget or business plan! Yikes! How in the world can you manage anything if you don’t even know where you want to go? I believe this is called “managing by the seat of your pants” which is not a method I would recommend to anyone.

Anyway, I hope you have found this article useful and somewhat entertaining. If you would like to contact me, you can do so by emailing me at mike.clough@bestbizpractices.org or visiting my LinkedIn page.

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Responses

I really like the one about the 80/20/30 complainers rule. Ha!

Thank you Mike for a solid set of baseline rules to help manage a business. Most business owners would find it helpful to add these rules on their businesses Dashboards along with the company’s budget and business plan.

Thanks Mike for this very solid advice. Reminds me of the Italian economist Pareto & his 80/20 rule. I find that it is right most of the time: 20% of your efforts bring in 80% of your results, 20% of your staff bring in 80% of the business & 20% of your customers give you 80% of your aggravation, etc.

Having been self-employed for 33 years, this article rings very true! I look forward to hearing more from you.

Hi Mike,

I love your advice–and the website with rules of thumb–How fun, and practical!!!

Also thought I’d mention that some people have said the origin of the expression rules of thumb –is old England–that a man wasn’t allowed to beat his wife with anything wider than his thumb– Now that didn’t stop me from using the term in our book (since my father thought I was being silly to worry about it and we were writing it together). Just thought I’d let you know words are funny things some times! Thanks again for the pertinent thoughts- Laura Daley

Someone else told me the same thing. Wikipedia says:

“The term is thought to originate with wood workers who used the width of their thumbs (i.e. inches) rather than rulers for measuring things, cementing its modern use as an imprecise yet reliable and convenient standard. This sense of thumb as a unit of measure also appears in Dutch, in which the word for thumb, duim, also means inch.”

It goes on to say “Another possible origin of the phrase comes from measurement, particularly in agricultural fields. The plants need a fairly precise depth to seed properly, whether planted from seed or being replanted, but the depth can sometimes be estimated using the thumb. That is, a rule “(measurement) of thumb.”

Finally Wikipedia also says, “It is often claimed that the term originally referred to a law that limited the maximum thickness of a stick with which it was permissible for a man to beat his wife, but this has been discredited. British common law before the reign of Charles II permitted a man to give his wife “moderate correction”, but no “rule of thumb” (whether called by this name or not) has ever been the law in England. Such “moderate correction” specifically excluded beatings, only allowing the husband to confine a wife to the household.”

But it is fun to talk about. :-)

THE 80/20/30 RULE
If you get rid of the 20 percent of your customers who cause 80 percent of your headaches, your profit will increase by 30 percent.

I love this rule. I actually saw an owner decide to implement it and the top salespersons in the company took all of his clients that were causing the headaches and created a new company. They are still in business. He is gone.

Jeff, I am not clear with your comment. Who is still in business and who is gone?

Thanks for this, Mike. Love the idea of charging twice as much and getting half up front for the deliquents. I’d add to this estimating double for cleints who make everything an urgent rush because they can’t get their act together until the 11th hour. I’ve always prospered from working with clients like this as most can’t, but I’ve learned to slate off the anticipated week (and urge my vendors to do the same), deliver and get rave reviews and recommendations from the client (and a justifiable additional fee for the stress and associated challenges).

Nanette, I really liked that one myself. In fact, I used it today in counseling a client. :-)

Mike, The owner who decided to get rid of his troublesome clients. Sorry, if this was not clear. This owner has closed his doors but the employees who took the abandoned clients are still in business, doing very well and have few complaints from those troublesome clients.

Their philosophy is very consumer oriented. They also focus on educating their customers upfront on the process, systems and who to contact when there is an issue.

Jeff, this reminds me of another rule of thumb: “There is an exception to every rule under the sun.”

Mike:

Thanks for sharing. I like the rules of thumb; 2 specifically I have tried to explain to people for years you have:

The customer is NOT always right, or your 80/20/30 RULE
If you get rid of the 20 percent of your customers who cause 80 percent of your headaches, your profit will increase by 30 percent.

Slack (a good book by Tom DeMarco), or your GETTING WORK DONE
People do best when they’re working at 80 percent of their capacity. At 50 percent, they get bored. At 100 percent, stress gets them.

When you think about the slack rule and what layoffs do to those left (more with less), it’s no wonder people call it a death spiral.

Interesting article and I enjoyed reading your tips as I have my own small business to run :)

So why would it make sense to manage by a method that “is not intended to be strictly accurate or reliable for every situation”?

Because it is better to measure the right things with a little bit of inaccuracy than the wrong things with laser point precision.

I agree with you that financial information shoudl be presented to small business owners in as few pages as possible. Here is a sample of the one page summary I provide for my customers.

http://www.keepandshare.com/doc/view.php?id=1800190&da=y

Great point Brenda! And I liked your sample report. The one thing missing from the report was a MTD and YTD comparison to the budget.

At least once a year (more frequently if there are major changes), I invest considerable amount of time in analyzing and preparing a budget that I believe can work and it becomes my goal or target.

Then I like to compare my actuals to my budget every month to see how I am doing MTD and YTD. This points me to where I should focus if I want to achieve my budget. And if I am missing a part of my budget consistently, I will need to either tweak what I am doing or tweak the budget.

If I find I need to tweak the budget, then I have to look at the overall ramifications of the tweak. Does the budget still work and get me to the goals I desire? If yes, great! If no, then it is time to rework the budget into something that will work.

I realize that “managing by the seat of your pants” is far easier. However, it leaves you wide open to many nasty surprises that can leave you in a position in which it is impossible to get back on the road to success.

You’re right Mike, budget to actuals are also important. The software that creates this one page reports also creates budget to actual reports. It just doesn’t all fit on one page. The report I featured here is good for focusing on operations. There is also another two page report that focuses on financial performance by providing the “The Three Bottom Lines” analysis.

[...] of a small business is between seven and ten times the average profit of the last three years. (bestbizpractices.org) ← there are several other great ones on this [...]

I am sorry to inform you that Mike Clough passed away and is no longer managing this blog. I am in the process of taking over for him. Regrettably, at present, I am unable to respond adequately to your comment.

“Managing By Rules of Thumb | America’s Best Business Practices” ended up being a great article and also I personally was indeed really glad to find the blog post. Thanks-Matthias

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