Accountants and CFOs have many different types of financial statements and projection methods to use for sales forecasting. Choosing the best in a given situation can lead to better business decisions and faster growth. If you’re looking to gauge a fast-growing or a new company’s future performance, the revenue run rate is one useful metric to consider.
What is Run Rate Revenue?
A revenue run rate, sometimes called a sales run rate, is a way to measure financial performance and predict future revenue.
An accurate revenue run rate must assume there will be no dramatic changes to the economic climate or your product lines or services during the year, and sales will remain steady. A revenue run rate works if your current revenue trends remain the same for the year.
For a business celebrating its first profitable quarter, for example, run rate revenue figures can set reasonable expectations for the rest of the year or even the following year.
Using a revenue run rate can provide accurate annual sales predictions in a variety of scenarios. Revenue run rate works as a useful metric for:
- New companies
- Fast-growing companies
- Companies with significant recurring revenue (ARR or MRR)
If you don’t have a lot of past data to draw on, for instance, in a new business, you can use run rate calculations to extrapolate annual revenue based on monthly revenue or data from your first quarter. If seasonality doesn’t come into play, annualizing revenue can give you a good idea of where you can expect your sales revenue to be in the next 12 months.
Companies in seasonal industries, however, may not find their run rate calculations accurate because sales trends shift throughout the year.
For instance, a landscaping company in the Northeast U.S. could not use its quarterly revenue from the first quarter to calculate annual revenue. Unless the company also offered snow removal services, evaluating monthly sales for landscapers in January, February and March would paint a bleak picture, indeed.
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How To Calculate Run Rate Revenue
There are a few different methods for calculating your revenue run rate, depending on the need to account for seasonality or time-based weighting. .
Exit Rate Method
For SaaS and subscription-based companies, using the exit rate from the last month’s recurring revenue (MRR) is the simplest method.
Let’s say a SaaS company earned $2M in monthly recurring revenue in December, plus another $1M in one-time sales for total monthly revenue of $3M. They aren’t planning new product releases or expanded promotions, and they intend to keep their marketing budget the same for next year.
They can project their revenue for next year by calculating their run rate from December’s sales figures.
$3M X 12 months = $36M
However, there are some problems inherent in this formula. It does not account for new customers, lost customers, or churn. Using MRR, Monthly Recurring Revenue, as the starting point for calculating ARR can offer more accurate predictions.
How to Calculate MRR
Add your baseline MRR, or the MRR at the start of the time period, to revenue from new customers and subtract revenue lost to churn and downgrades.
Using MRR, Monthly Recurring Revenue, calculations, and then proceeding to calculate ARR, can provide a better picture of a company’s cash flow and stability.
Last Quarter Annualized (LQA) Method
Another common method for calculating run rate revenue, especially on an annual basis, is to annualize the last full quarter’s actual revenue. In other words, take the prior three month’s actual revenue, and multiply by four (4) to calculate an annual run rate revenue forecast. This method is useful for a quick forecast that is more rounded with less chance of variability than the single month’s exit rate times 12.
Rolling Average Method
Similar to LQA, revenue run rates can also be calculated using a rolling average of a certain number of months. Most commonly, rolling average run rate revenue forecasts are calculated using a six-month (6 month) rolling average. By using this method, run rate revenue forecasts are further smoothed out from any exceptional or outlier months.
For example, in the screenshot below, the run rate revenue forecasts for the periods August to December are calculated using a rolling six-month average. August’s forecast is calculated by taking the average of the six months from February to July.
How To Use Run Rate Revenue
Businesses can use run rate revenue for a number of purposes. Start-ups less than a year old can benefit from run rate revenue calculations, since they do not have historical data to draw from. Likewise, businesses with newly created departments, new products, or new profit centers can benefit from run rate revenue to predict future growth. If a business is experiencing its first profitable quarter, looking at run rate revenue may be more insightful than historical analysis.
Similarly, if a business isn’t a startup, but has fundamentally changed its business model, historical data may not be accurate. Run rate revenue figures can give indications of how the changes may affect revenue across departments. Here are a few ways you can use business insights derived from run rate revenue figures as part of your financial forecasting.
- Set sales goals – Calculating your sales run rate can give you a good idea of realistic end-of-year sales goals. Setting annual revenue goals that exceed your run rate may be too ambitious. But in many industries, especially in companies that rely on monthly recurring revenue, it’s reasonable to expect your earnings for one month will remain stable in future months.
However, if you seek to exceed your run rate, you’ll want to increase sales for future months through promotions, advertising, or one-time sales.
- Get a quick look at your projected revenue, especially in a new company – The quick and easy calculations for run rate revenue lends itself well to gauging your company’s current and future financial health if sales continue along the same trajectory.
Sales teams like using run rate revenue calculations so they can see how well they can expect to do over the course of the year.
Additionally, new companies may not have more accurate figures to rely on, so run rate revenue can help set expectations.
- Adjust budget based on projected annual run rate revenue – Knowing your run rate revenue can help you allocate budget where it’s needed. If you see revenue predictions that may fall short of past years, you may want to find ways to reduce expenses and save money or boost sales.
On the other hand, be skeptical of higher-than-average run rate revenue figures. A number of factors, including one-time sales, seasonality, or market trends, could lead to higher-than-expected run rates that don’t pan out.
- Make business growth decisions – Can you afford new manufacturing equipment or capital improvements? Looking at your run rate revenue may help you decide.
- Manage inventory – If you have accurate run rate calculations based on a time period that is truly indicative of annual sales, you can use it to manage inventory better so you don’t overstock or run out of merchandise on a monthly basis.
Risk Of Using Run Rate Revenue
However, run rate revenue is not a perfect calculation. Using run rate revenue figures to make decisions carries certain risks because it does not take into account every aspect that drives revenue for your business.
Annual revenue predictions do not take into account seasonality or your company’s growth rate. Here are a few risks to using run rate revenue:
- Investors may not take these calculations seriously – Most investors do not view run rates as accurate revenue predictions. If you have a start-up and you’re seeking financing, your run rate revenue won’t reflect the business growth you may expect to see as you ramp up your marketing and advertising efforts. You could be selling yourself short.
On the other hand, if you came out strong, but the sales curve flattened or you experienced high churn, you risk disappointing investors with high expectations that you can’t deliver.
- Using run rates to budget can lead to overspending – An optimistic run rate can lead to overspending. This can create cash flow problems.
Automate Your Run Rate Revenue Calculations
Run rate revenue calculations represent an easy way to see how a company is doing overall. By managing and maintaining your account-by-account revenue run rates in one system, you can improve the accuracy of your revenue forecasts and expectations.
revVana software integrates with your Salesforce CRM to ensure accurate run rate revenue figures for better revenue predictions. Reach out now for a free demo.