What is the run rate?
Revenue run rate is a financial performance indicator that estimates your company’s upcoming revenue over a period of time based on previous earnings. It is usually calculated for an entire year, but you can also estimate run rates for shorter or longer periods.
The longer the time frame is, the more accurate your run rates will be because they are based on more historical data. Short-term run rates might not offer the same insight into company growth since you would be projecting profits based on very little information.
This economic forecasting tool is essential for predicting long-term growth, especially for SaaS companies. However, accurate run rates are based on the assumption that nothing will change for your company in, let’s say, a year – same churn rates, same customers, same ARPU, same company size.
This approach is unrealistic when considering fluctuations in the political landscape, economy, seasonality, potential company growth, etc.
When you combine run rates with other company growth metrics, such as sales linearity, next quarter pipelines, etc., you will have a better projection of your company’s evolution. Let’s see how to calculate run rates on an annual basis but also based on other timeframes.
Related: Growth Metrics Every SaaS Business Should Track
How to calculate run rate
Here is the standard run rate formula you can use to calculate both annual run rates as well as run rates for shorter time frames:
The annual run rate can also be calculated by multiplying the Revenue in one month by the number of months:
Annual run rate = Revenue in period Y x Number of periods Y in one year
Companies can modify and adapt the formula so that it makes more sense for their business model. As a SaaS business with pay-as-you-go and subscription packages, we estimate the run rate using three months of historical data.
Similarly to the second formula in the image above, we multiply the last three months of Revenue by four (12 months). This helps us estimate revenue growth more accurately.
Benefits of calculating run rate
Why should you know how to calculate run rates and how will this help grow your business? Here are the main benefits:
- Future growth insight;
- Future earnings estimate;
- Smart budgeting;
- Future savings overview;
- Optimized inventories;
- Ideal company benchmark.
Now let’s dig deeper and see precisely why calculating run rates is essential for every company:
Run rates calculation helps companies predict revenue growth and achieve a general outlook on company health. This way, managers can start planning future expenses and think about expansion or, on the contrary, about reducing budgets.
If your company is going through operational changes, run rates can help estimate if these changes will impact the business.
Regarding stock options, run rates reflect the average annual dilution of your company’s stock. This metric can only be estimated accurately for companies that have been on the market longer since the best estimations consider company evolution over a minimum 3-year span.
Rapidly expanding subscription-based companies benefit most from calculating run rates. This helpful benchmark metric is an excellent indicator for evaluating internal initiatives, like the launch of a new product or structural changes in the company’s organizational scheme. SaaS companies can tell if the changes they plan to implement are worth it just by looking at run rates.
Problems with run rate
Run rates are very hard to calculate when it comes to fast-growing companies. This is also the case with companies going through changes, like launching a new product or modifying their price structure.
Because the run rate is calculated based on a presumed even income distribution throughout the year, it can fall short when seasonal fluctuations come into the picture. Here are some cases where run rates might be less accurate:
Holiday and seasonal industries
Calculating run rates based on temporary spikes will not yield accurate results. For example, companies that sell Christmas decorations will have very low sales figures during the off-season. Run rates offer insight into a company’s future profits only if that company’s revenue is consistent throughout the year.
Another related problem is the one companies face when registering many one-time sales. A large volume of one-time sales throws off run rates’ accuracy because they are based on repeated purchases and repeated client patterns, which enhance future profit predictability.
Company changes, future market fluctuations, and trends
In the case of companies that are on the verge of launching a new product, things get tricky: run rates might be inaccurate if you calculate them immediately after a product launch. Sales will register significant spikes and subsequent drops during this time.
Run rates are calculated taking into account past data. If your company registered significant growth, say, this time last year, it doesn’t mean it will happen again next year. Accurate future performance predictions should also consider other factors, like emerging market trends, global conflicts, resource depletion, etc.
Contractual limitations and expiry dates
Most companies run on set contracts. These include utility suppliers, rent, outsourced projects, service providers, and services /products they provide. If you calculate estimated profits without considering how many contracts will expire in the upcoming year, your estimations will be far off.
Difference between run rate and recurring revenue
Annual or Monthly Recurring Revenue (ARR and MRR), are subscription-based economy metrics. It shows how much money subscriptions earn for your company on a yearly basis.
Unlike the Annual Recurring Revenue, the Annual Run Rate is a projection of how much you stand to make off a certain subscription based on what they spent in the past.
What run rate means for investors
Run rates help business managers make better decisions based on accurate company insights, devise better growth strategies, and administer their resources more effectively.
They are also instrumental in tracking company progress and seeing how your company is positioned in the marketplace compared to the competition.
When run rates fall short compared to last year’s earnings, managers can find new ways to minimize expenses and look into innovative ideas to increase sales.
Lead investors should consider both annual run rates and annual recurring revenue when they advise the company and the other investors they represent.