How much is your business going to earn in the next year?
It's a tough question to answer, but one that’s important to investor reporting, capacity planning, and capital investment decision-making.
One way to forecast that is to use your run rate, a financial metric that projects future revenue based on current performance.
In this article, we’ll explain what run rate is, discuss how to calculate it, and detail the benefits and limitations of this financial measurement.
What is a run rate?
Definition of run rate
Run rate (also known as revenue run rate) is a financial metric that uses a company’s current performance to predict future revenue.
It's calculated by annualizing recent revenue figures, making the assumption that the same level of performance continues over time.
For instance, if your business earns $500k in the first quarter, its run rate would be $2 million, assuming that the Q1 performance continues throughout the remainder of the financial year.
Common uses of run rate in financial analysis
Run rate is used in a number of different financial scenarios, including:
- Revenue forecasting: Used by startups and high-growth companies to estimate future earnings.
- Investor reporting: Helps demonstrate business potential during fundraising or valuation discussions.
- Performance benchmarking: Compares revenue trends over time or against competitors.
- Budgeting and resource planning: Aids in scaling operations, hiring, and inventory management.
Run rate vs. other financial metrics
Run rate can be a useful metric for quick revenue projections, but it's best used alongside other financial metrics like:
- ARR (Annual Recurring Revenue): Used in SaaS and subscription businesses, focusing only on predictable, recurring revenue.
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): Measures profitability rather than revenue.
- Cash flow: Tracks actual cash movement rather than projected earnings.
How to calculate revenue run rate
Run rate formula
To calculate your revenue run rate, you’ll need this formula:
For example, if you’re using one quarter’s revenue to extrapolate and calculate run rate, the formula you’ll apply will be:
Revenue for the quarter x (12 / 3)
Let’s walk through an example to illustrate.
First, you determine your revenue for the period in question. In our case, the period is a quarter, and the revenue is $2m.
Then, you apply the formula:
$2m x (12 / 3) = $8m
Examples of revenue run rate calculation
To illustrate further, here are a few scenarios in which run rate can be calculated for different time periods.
Example 1: Monthly revenue projection
A SaaS company generates $50,000 in revenue in January. To estimate its annual revenue run rate, we calculate:
$50,000 x 12 = $600,000
Projected annual revenue: $600,000
Example 2: Quarterly revenue projection
An e-commerce store earns $300,000 in Q1 (January–March). It calculates its run rate as:
$300,000 x 4 = $1,200,000
Projected annual revenue: $1.2 million
Example 3: Weekly Revenue Projection
A gym earns $10,000 in a single week.
They use this formula to calculate their annual run rate:
$10,000 x 52 = $520,000
Projected annual revenue: $520,000
Benefits of using run rate
Like most financial measurements, run rate has some pros and cons. Let’s start with the pros, which include:
- Simple and fast estimate of future performance. Run rate provides a quick way to project annual revenue using recent financial data, making it useful as a “quick sketch”
- Useful for benchmarking. You can compare your run rate with competitors or industry standards to see where you stand.
- Can support short-term decision-making. Businesses use run rate to make short-term operational decisions, such as hiring, scaling production, or adjusting budgets based on expected revenue.
- Helpful for capacity planning. Businesses can use run rate to estimate future demand and allocate resources, such as reviewing inventory management practices or deciding to invest in additional staffing.
- Assists in raising funds and business valuation. If you’re looking to raise funding, run rate can be an important figure to include in investor pitches to showcase potential future earnings.
Limitations and risks of run rate
Revenue run rate isn’t a perfect metric, however. Let’s turn our attention to some of the downsides of run risk:
- Assumes constant growth. Any run rate projection relies on the assumption that current revenue levels will continue for the rest of the year. This is rarely true, and often leads to overestimates (and sometimes underestimates) of revenue.
- Overlooks one-time events and seasonality. Similarly, run rate doesn’t consider one-time events like a holiday sale or landing a big contract, which can inflate run rate estimates. Seasonal slowdowns can also make it unreliable and inaccurate.
- May mislead investors. If run rate is used without context or other figures like burn rate, it can lead to unrealistic expectations and overvaluation. This is especially true in industries where revenue regularly fluctuates or in the case of early-stage startups experiencing rapid but unsustainable growth, something that is not uncommon when gaining early traction.
- Ignore cost variability. While run rate focuses on revenue, it doesn’t account for rising expenses, operational inefficiencies, or unexpected costs that could impact profitability.
- Doesn’t factor in economic conditions. External factors like recessions, inflation, or industry downturns can significantly affect future revenue, which can render run rate projections inaccurate.
Strategies to mitigate risks when using run rate
Run rate may be flawed, but that does not make it a useless metric. In fact, most financial measurements have at least on drawback.
The key here is to implement strategies to counterbalance the risks associated with using run rate.
Here are a few ideas.
Adjust for seasonality
Use historical data to identify seasonal trends and adjust projections accordingly to avoid creating misleading revenue estimates. Applying a weighted adjustment helps maintain a more accurate forecast.
For example, if you see a 40% revenue increase every December, you should adjust your annual run rate by normalizing holiday sales rather than extrapolating them across the entire year.
Exclude one-time events
Large, non-recurring deals and temporary promotions can inflate revenue forecasts, leading to unrealistic expectations. By removing these anomalies, you can get a clearer picture of your sustainable revenue stream.
For example, if you land a one-time $500K enterprise deal but typically close $50K in monthly subscriptions, including that deal in your projections would significantly distort expected future revenue.
Use multiple timeframes
Comparing monthly, quarterly, and annual run rates helps identify inconsistencies and smooth out short-term fluctuations.
For example, if your business is growing fast, your monthly run rate might look high, but comparing it to your quarterly trend can reveal whether that growth is stable or just a short-term boost.
Incorporate expense trends
Revenue projections alone don’t tell the full story, and expenses should be analyzed alongside them to assess profitability. If costs are rising at the same pace or faster than revenue, your financial health may not be as strong as it appears.
For example, if you project $10M in annual revenue, you also need to account for rising operational costs like hiring and infrastructure to ensure you’re not scaling revenue at the expense of profitability.
Factor in market conditions
Economic trends, industry shifts, and external risks can impact revenue forecasts, making it crucial to adjust projections based on broader market insights. Factor expectations in where possible.
For example, if your construction firm is seeing a rise in contracts but interest rates are expected to increase, you should adjust your projections downward to account for the potential slowdown in real estate development.
Combine run rate with other financial metrics
Run rate is useful, but it should be evaluated alongside key financial metrics like ARR, EBITDA, and cash flow to get a complete picture.
For example, if your run rate looks strong but your cash flow is weak, you might struggle with liquidity. That’s why you need to balance revenue forecasts with an understanding of expenses and capital reserves.
Regularly update projections
Revenue run rates should be continuously reassessed as new financial data becomes available.
For example, if your subscription-based business suddenly sees an increase in churn, you need to adjust your run rate to account for declining customer retention rather than assuming past revenue trends will continue.
Add run rate to your reporting dashboard
Run rate is a valuable metric for quick revenue projections, but it’s most effective when used alongside other measurements to provide a clearer picture of your company’s financial health.
By adjusting for seasonality, accounting for expenses, and considering market conditions, you can make more informed business decisions and avoid misleading forecasts.
Want to track run rate changes over time?
With BILL’s advanced reporting tools, you can integrate run rate calculations into a custom financial dashboard that gives you deeper insights into revenue trends, cash flow, and operational expenses.
