What is a Rule of Thumb?
The rule of thumb is colloquially referred to as a thumb rule. A thumb rule is a guideline which provides concise advice on a given subject. It is a general concept that offers specific guidance for executing or approaching a given task. Thumb rules usually evolve as a result of practice and experience rather than a theoretical study.
The Rule of Thumb Explained
Investors may be familiar with several "financial thumb laws" aimed at helping individuals understand, recall, and apply financial guidance. The thumb rules describe strategies and procedures for saving, borrowing, purchasing a house, and retirement planning.
While a thumb rule may be suitable for a broad audience, it does not apply equally to any single collection of circumstances.
The thumb rules are useful to people as general instructions. In other cases, they can be too simplistic, leading to an underestimation or overestimation of an individual's needs. Thumb rules do not compensate for particular conditions or variables that exist at a given time, or that may change over time, which should be required for sound financial decision making.
General Rule of Thumb in Business
For business, the term 'rule of thumb' is nothing but a guideline that provides simplified advice about a specific subject or for achieving a goal or addressing a particular task. It can never be precisely defined and accurate in the application.
While beginning a business, there is an average time to liquidate an equity investment in any given startup company, i.e. five years. Hence the rule of thumb is a newly established company should provide a five-year financial projection. Investors will mostly demand a five-year forecast to understand the opportunities and risks involved in investing in that business.
The application of Pareto's Principle of 80/20 rule is the best thumb rule example for a growing business. The owner can evaluate which customers or clients deliver the most profit since 80% of the profits of the company is earned from just 20% of its customers.
The standard rule of thumb while selling a business is the use of various metrics to evaluate the net worth of the business. One of the parameters is the EBITDA (earnings before interest, taxes, depreciation, and amortisation).
