There are many metrics to consider when determining the financial success and viability of your business. One such measure – revenue run rate estimates a company’s future revenue based on recent weekly, monthly or quarterly revenue, expenses, or other key metrics.
It’s a popular metric especially among startups, software-as-a-service (SaaS) companies, subscription-based business, and fast-growing organizations. It uses recent financial information like current sales and revenue to forecast future performance. Given that it draws conclusions based on current financial data, this figure comes with an assumption that the company’s current financial environment will remain relatively stable, making this metric impractical for seasonal industries.
The Ins and Outs of Run Rates
Let’s dig into what is a run rate and why companies track them (spoiler, there are lots of reasons). Developing companies may use revenue run rate to raise funds for the business. A company that doesn’t have an established credit record may use it to secure funds. And, companies, regardless of the size or how long they’ve been in business, may use revenue run rate to see whether internal changes have improved the company’s financial performance.
Calculating Run Rate Rates
Revenue run rate is a simple formula, and it’s calculated by:
Revenue Run Rate (Annual) = Revenue in Period x Number of Periods in One Year
Monthly example: If a company generates $500,000 in revenue in one month, the annual revenue run rate would be $6 million per year.
$500,000 x 12 = $6M
Quarterly example: If a company generates $1.5 million in a quarter, the annual run rate would be $6 million per year
$1.5M x 4 = $6M
Run rates can be broken down further by project. Project run rate refers to the projected cost or revenue of a project over a specific period. Like revenue run rate, it extrapolates from current financial trends.
There are three types of project run rates – cost, revenue, and burn rate. Let’s look at each of these in a bit more detail.
- Cost run rate consists of the total project cost based on current expenditure trends.
- Revenue run rate consists of the projected revenue if the project continues to generate income at its current rate.
- Burn rate is the speed at which a project is consuming its allocated budget.
Project run rate is another important metric in that it helps in budget forecasting, identifies cost overruns early in the process, assists in financial planning and decision making, and helps in identifying potential financial risks.
Project run rate example: If a project costs $50,000 over a quarter, the annual run rate for this project would be $200,000.
($50,000/3) x 12 = $200,000
The project run rate is for budget forecasting, performance evaluation, adjusting resources and timelines and predicting annual revenue. However, also like revenue run rate, fluctuations like seasonal variances and unexpected events need to be taken into consideration.
Revenue Run Rate: It’s Importance, Benefits and Limitations
An important metric, revenue run rate provides a quick snapshot of the company’s financials or performance trajectory. More specifically, it helps businesses estimate future performance based on current trends, assists businesses in setting financial goals and resource allocation, helps the company compare progress quarter-over-quarter or year-over-year, provides quick financial insights, and enables investors and stakeholders to better gauge a company’s potential revenue.
Like virtually all financial metrics, revenue run rate provides businesses with benefits as well as has some inherent limitations.
Benefits:
- Provides a fast and easy way to estimate future revenue based on current metrics
- Helps companies make strategic decisions without time consuming, complex financial models
- Enables businesses to set revenue targets and track performance
- Provides a benchmark for marketing and sales efforts
- Enables businesses to better plan for expenses
- Helps companies determine whether they should scale up their operations or reduce costs
- Enables startups and SaaS companies to use revenue run rate to forecast annual recurring revenue (ARR)
- Allows subscription-based businesses to estimate future revenue from their active subscribers
Limitations:
- Businesses with seasonal financial fluctuations such as retail, hospitality and travel, eCommerce, home renovations, HVAC services, etc. may receive misleading revenue projections if they base their revenue run rate on peak or slow periods
- Revenue run rate doesn’t account for market changes, competition, or economic downturns
- Startups with inconsistent revenue may have erratic revenue run rates
- Revenue run rate doesn’t factor in customer churn, which is an important metric for SaaS and subscription-based businesses
- If a company closes a few very large deals or receives large one-time payments, revenue run rate may be inflated, skewing revenue expectations
- Since revenue run rate extrapolates from current data, it lacks the ability to provide a holistic financial forecast
While revenue run rate is useful for quick financial projections, as you can see it has limitations. Given its limits, it’s best used in conjunction with other metrics like monthly recurring revenue (MRR).
MRR and Revenue Run Rate
While sometimes used interchangeably, revenue run rate estimates future revenue based on current performance, while MRR tracks predictable monthly income. Simply put, MRR is the predictable and consistent revenue a business earns from subscriptions or recurring payments.
MRR enables businesses to more accurately forecast revenue, assess growth trends, and make informed financial decisions. While there are numerous types of MRR, we’ve listed the top four.
- New MRR: Revenue from new customers acquired during the month.
- Expansion MRR: Additional revenue from existing customers through upgrades, cross-sells, or add-ons.
- Churned MRR: Lost revenue from customers that canceled or downgraded their subscriptions.
- Net MRR: Total MRR after new, expansion, and churned MRR are factored in.
MRR also provides accurate and reliable forecasts of future revenue. Additionally, it enables companies to:
- Measure growth over time and assess the effectiveness of its marketing and sales efforts.
- Track how revenue is increasing or decreasing over time.
- Gain insights into customer retention and churn.
- Evaluate the impact of pricing changes, upselling, and new market expansion.
- Understand customer behavior to refine retention strategies.
- Provide a key metric to investors and stakeholders for evaluating the company’s financial health, sustainability, and scalability.
Let’s switch gears a bit and look at run rate compared to forward rate.
Run Rate vs. Forward Rate: Similarities, Differences and Risks
While both run rate and forward rate are financial metrics, their uses differ.
Run rate provides a projection of a company’s future performance based on its current financial results and assumes that the current rate of revenue, expenses, etc. will continue throughout the year. On the other hand, forward rate is an interest rate that is applicable to a financial transaction that will take place in the future. The rate is derived from present market conditions and reflects expectations about future economic factors like supply and demand, inflation, etc.
While it helps businesses anticipate future borrowing or lending costs, it is based on market expectations which may not always be realized. Businesses use forward rate for three key reasons:
- To protect against exchange rate volatility.
- To reflect market expectations of future interest rate changes.
- To take advantage of pricing differences in two or more markets.
Let’s do a direct comparison between run rate and forward rate.
Run Rate | Forward Rate | |
Definition | Projected financial metric | Expected future interest rate |
Purpose | Business forecasting | Financial market analysis |
Use | Startups, growing companies, revenue projections | Bond markets, foreign exchange, agreements/contracts |
Risks | Overestimating future revenue due to seasonality, changes in performance, customer churn, revenue spikes, etc. | May not reflect actual future rates due to market changes |
How to Improve Your Revenue Run Rate
Wondering how to improve run rate? It requires a mix of revenue growth and cost efficiency strategies, and here are some proven improvement methods:
- Use a rolling average instead of a single month
- Consider market trends and all external factors
- Monitor and update revenue run rate regularly
- Group customers into segments based on their behavior
- Increase revenue by improving sales and marketing efforts, conducting targeted upsell and cross-sell initiatives, enhancing customer retention strategies, and introducing new revenue streams
- Reduce costs by optimizing operational efficiency
- Buy in bulk and/or renegotiate purchasing contracts
- Improve inventory management
- Enhance workforce productivity through training and hybrid working conditions
By implementing even a few of the above, you’ll see rapid improvement in your revenue run rate and be on your way to recognizing more revenue.
Boost Your Revenue Using Financial Metrics
While revenue run rate and revenue recognition are related, they serve different purposes in financial analysis and accounting. From a relation perspective revenue run rate is based on recognized revenue. Additionally, it helps in forecasting, while revenue recognition ensures accuracy.
When we look at the differences, revenue run rate helps businesses estimate annualized revenue for forecasting, whereas revenue recognition ensures compliance with accounting standards like ASC 606 and IFRS 15. While revenue run rate is forward looking, revenue recognition follows specific rules on when revenue received can be recognized. However, what they both have in common is in providing the data needed to help ensure your company is running efficiently and profitability.
Curious about other ways you can boost revenue? Let our team help!
