What is the Run Rate?
The Run Rate is the expected performance of a company estimated from extrapolating data from a recent period assuming that current conditions will continue.
- What is the definition of run rate?
- What is the formula for calculating the run rate revenue?
- For which types of companies are run rate metrics typically used?
- When might run rate metrics be improper to rely on?
Run Rate Definition
The run rate of a company is defined as the projected financial performance of a company, with the basis of the forecast being recent performance.
For the run rate of a company to be practical, its recent financials must be more representative of the company’s actual performance and future trajectory rather than its historical data.
Moreover, the run rate of a company assumes that the current growth profile of the company will persist.
In particular, the run rate is most often utilized for high-growth companies that have been operating for a limited amount of time – i.e. the company is growing at such a rapid pace that run rate metrics capture the expected performance more accurately.
For a startup figuring out its go-to-market strategy and in the initial stages of development, each quarter can consist of significant internal adjustments.
As opposed to relying on actual LTM financials, which could underestimate upcoming performance, run rate metrics are more likely to depict the real growth potential of the company.
Run Rate Revenue Formula
Revenue is the most widespread metric calculated on a run-rate basis.
To calculate the run rate revenue of a company, the first step is to take the latest financial performance and then extend it across for one entire annual period.
Run Rate Formula
- Run Rate Revenue (Annual) = Revenue in Period * Number of Periods in One Year
If the chosen period is quarterly, you would multiply quarterly revenue by four to annualize the revenue, but if the period is monthly, you’d multiply by twelve in order to annualize.
Let’s say, for example, that a high-growth software startup has generated $2 million in its last quarter.
If the startup is pitching itself to venture capital (VC) firms to raise capital, management could state their revenue run rate is currently approximately $8 million.
- Run Rate Revenue = $2 million * 4 Quarters
- Run Rate Revenue = $8 million
However, for the $8 million run rate revenue to hold credibility to early-stage investors, the startup’s growth profile must match the projected revenue growth rate – i.e. the market share upside and opportunities for increasing customer count and/or pricing.
Drawbacks to Run Rate Financials
While run rate metrics can be more representative of future performance, these metrics are still simple approximations at the end of the day.
The simplicity of the run rate concept is the primary drawback, as it assumes recent performance can be held constant for purposes of forecasting.
Since the recent monthly or quarterly performance is extended for the entirety of a projected year, the run rate can be deceiving for companies with seasonal revenue (e.g. retail).
For that reason, run rate metrics should generally be used carefully when it comes to companies with fluctuating customer demand or revenue that is typically weighted in the front-half or back-half of the year.
More specifically, certain companies/industries observe:
- Higher Customer Churn Rates at Certain Periods of the Year
- One-Time Major Sales
- Potential to Derive Higher Revenue (i.e. Expansion Revenue from Upselling/Cross-Selling)
It is important to note that run rate financials do NOT account for any of these factors.