As a small business owner, you've probably heard the term "run rate" before. But do you know what the term actually means—and why it's important?
Run rate is important because not only does it give you insights into your current sales, but it can also help you predict what your sales could look like in the future—information that can be super valuable when making decisions about how to move your business forward.
But in order to make the most out of this revenue data, you need to really understand it. Let's take a dive into all things run rate: what it is, why it's important, how to calculate it, and how to determine if it's data that can be useful for your business's next chapter.
What is Run Rate—And Why Is It Important?
Run rate is a metric that can be used to estimate a company's future financial performance based on its current (or recent) financial performance.
As a business owner, you can use run rate to determine sales revenue or profit for the next year—based on your existing sales figures from the last month or quarter.
Run rate is also known as revenue run rate or annual revenue run rate.
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How Do You Calculate Run Rate?
Fortunately, the run rate is easy to calculate. The formula looks like this:
Run rate = revenue in a time period x number of those periods in one year
To calculate run rate, just take your revenue over a specific period of time, then determine the number of periods that occur per year. Then, multiply those two numbers to get the run rate.
So, let's say your business made $3,000 in the first quarter of the year. In this case:
- "Revenue in a time period" = $3,000
- "Number of periods in one year" = 4 (since there are four quarters in a year)
So, to calculate your run rate, you would multiply:
- 3,000 x 4
- $12,000 would be your annual run rate
That's a rough prediction of how much you'll make in a year, but be careful–run rate does not take into account a ton of different factors, including seasonal fluctuations.
You can also calculate run rate by using your monthly revenue. Say your business made $26,500 last month. In this example:
- "Revenue in a time period" = $26,500
- "Number of periods in one year" = 12 (since there are 12 months in a year)
To calculate, you would multiply:
- 26,500 x 12
- $318,000 would be your annual run rate
That means you may make $318,000 this year.
When to Use Revenue Run Rate
Understanding your company's run rate can be helpful in a variety of situations, including:
1. Predict Performance for New Companies
Because it can be calculated with current data collected in a short period of time, run rate is a great way to predict performance for startups or young businesses that don't have a ton of historical data to use for financial projections.
And if you're off to a strong start, you'll have an attractive metric to present to potential investors—which could help you secure the funding you need to keep your business moving forward.
2. Inform Budget Decisions
When you're creating your budget, reviewing your run rate can help you understand how much money you may have to work with in the coming months—information you can use to guide your budgeting decisions.
Since a run rate will give you a revenue projection for the year, you can use that data to create a budget and growth plan that accommodates that projection and helps you use your cash flow to hit your business goals, whether that means hiring more employees or launching a new product.
3. Aid In the Sale of a Business
Are you trying to sell your company? Forecasting growth is a great way to make your business appealing to prospective buyers—especially if you're having a good month or quarter. The run rate will show prospective buyers what they can expect to make at your current trajectory. So, the higher your run rate, the more money they stand to make—and the more interested they'll be in buying your business.
Examples of Using Run Rate in the Real World
Want to see run rate in action? Let's take a look at a few business owner examples of how to calculate run rate—and how it can help a business:
Quarterly Run Rate
Leo recently started his own construction company. Things were slow the first month, with the company earning about $10,000 in revenue. But business really picked up about 10 weeks in.
By the end of his first quarter, Leo's revenue hit $180,000—and now, with some bigger jobs on the books, he's looking to secure a small business loan to upgrade some of his equipment and expand his marketing.
Because Leo's quarterly numbers are so strong, he would use his quarterly revenue to calculate run rate:
$180,000 (revenue in a time period) x 4 (number of those periods in one year) = $720,000 (run rate)
Leo can use this run rate to show lenders the revenue potential of his new business—and ideally, it will allow him to get a larger loan to make more improvements and continue growing his construction business.
Monthly Run Rate
Sara has been selling her handmade pottery and ceramics for several years as a hobby—but recently signed a contract to sell some of her goods in a popular retail shop. To meet the anticipated demand and increase in sales, she's looking for investors so she can upgrade her studio and purchase materials in bulk.
Though she historically hadn't made more than a few thousand dollars in annual sales, in her first month at the retail shop, she sold $6,000 worth of product—a trend she expects to continue now that her products are in stores.
Sara can use her first month to calculate run rate:
$6000 (revenue in a time period) x 12 (number of those periods in one year) = $72,000 (run rate)
Rather than focusing on her previous earnings (which reflected her side hustle days), Sara's run rate is more reflective of her future revenue potential now that she's shifted to her new retail sales strategy. This will make her a more appealing prospect to investors and could help her get the capital she needs to continue scaling her business.
The Risks of Run Rate
Run rate can offer some definite benefits to your business. It can help predict growth, profitability, and future financial performance based on current revenue numbers—which is particularly helpful for new businesses that lack past financial data.
It can help business owners showcase their company's revenue potential. And for certain business models, it can be extremely accurate at predicting future income (for example, subscription or recurring contract-based businesses).
But it also presents some definite risks. Because revenue run rate is only based on current performance—and doesn't require any historical data—it's easy to make it seem like your business is doing better (or worse) than it actually is.
For example, if you had a better-than-usual month—and used that month to calculate your run rate—it could make your business seem more profitable than it actually is. On the flip side, if you had a worse-than-usual month, it could make your business seem less successful. As such, forecasting a full year's profits based on a single month can be inaccurate.
Some other potential risks of run rate include:
- Don't take other variables into consideration: Run rate is a simple equation. But there are often other variables that should be considered when predicting sales or profits for your business—and some may be a more accurate, reliable metric for predicting future income. For example, you might look at your customer retention rate to determine what percentage of your current customers are likely to be with you through the end of the year. Or you might examine how long, on average, it takes deals to close—and then apply that to your current deals-in-progress to get a sense of your revenue potential in the coming months.
- Don't account for seasonality: Businesses in seasonal industries, like retail businesses that make the most sales around the holiday season or restaurants in summer destinations, who don't have steady income throughout the year—and for these types of businesses, calculating revenue run rate using monthly or quarterly revenue data won't give an accurate projection of annual revenue.
- Don't account for circumstantial changes: There are a variety of circumstances that happen throughout the year that could impact revenue, from a new product launch to opening a new location to an economic slowdown. But because run rate is calculated using revenue data from a short time period (like a month or a quarter), it doesn't account for these types of changes—which, again, can lead to inaccurate projects.
FAQs About Run Rate
Have more questions about run rate? Here are a few FAQs to help add some clarity.
What is run rate vs. revenue?
Revenue is the total money your business takes in over a set time period, while run rate is a prediction about future performance based on current revenue numbers. It's calculated by multiplying revenue in a period by the number of those periods in one year.
What is an EBITDA run rate?
EBITDA is your earnings before interest, taxes, depreciation, and amortization—or, in other words, your operating income. To determine EBITDA run rate calculations, you would use your operating income for the run rate formula.
What's the difference between ARR and run rate?
Annual recurring revenue, or ARR, is a measurement that's particularly helpful for SaaS and subscription-based companies. This number is calculated using recurring revenue numbers, which come from subscription and membership fees.
This is different from run rate because it's based on recurring revenue instead of variable sales. (Businesses that don't have subscriptions or memberships aren't able to use ARR as a metric.)
Run Rate and Your Business
Now that you know what run rate is and how to calculate it, it's time to decide if this revenue data can help you take your business to the next level. If you're looking to gain insights into customer behavior and understand fluctuations in the market and your business, this kind of extrapolation probably isn't the answer.
In this case, use the revenue run rate as supporting insights to other data points, not as the only data point.
But if you're looking to attract investors or buyers for your business, your revenue run rate can help show that your business is profitable, stable, and secure.
Whether you're just starting out or getting ready to retire, we hope you feel empowered to leverage the revenue run rate to improve your business and help you make your next big decision.