Alternate name: Revenue run rate
Let’s say a venture capital company is analyzing the projected growth of a potential investment, ABC Software, Inc. ABC Software is a startup that has only been in business for four months, which means it has little to no historical financials to analyze its growth projections. It has consistently produced at least $100,000 in revenue per month thus far. The venture capital firm decides to use a run rate to project the future performance of ABC Software, Inc. It takes the $100,000 monthly revenue and multiplies it by 12 months to estimate that the annual performance will be approximately $1.2 million. This same concept applies to a company that may be launching a new product, service, or department to expand the company. Decision-makers of a company can take the current financial numbers of the respective product, service, or department, and calculate a run rate to estimate future performance.
How To Calculate Run Rate
To calculate a company’s run rate, simply take the revenue of the company in a given time frame and divide that by the number of days in that period. Next, multiply that number by 365 to get the annual run rate. Here’s what the formula looks like: For example, if Company BSL had revenue of $900,000 in the first quarter of the year, you’d first divide that by the number of days in that quarter (900,000 / 90 = 10,000). You’d then multiply that by 365 to get the annual run rate of $3.65 million. You can also calculate the run rate by taking the current revenue for one month and multiplying it by 12, to get the annual run rate:
Annual Run Rate = 1 month of revenue x 12 months
For example, if Company HWG had revenue of $500,000 in January, you’d multiply that number by 12 to get the annual run rate of $6 million.
Pros and Cons of Run Rate
Pros Explained
May be useful for new companies: Companies with no earnings track record don’t have much information to use to create projections and financial forecasts. Using the run rate can be a great starting point to project how a company will likely perform in the future. Better for projecting long-term sales contracts or newly launched products: Products that have long-term contracts make a run rate even more accurate. Why? Because contracts give stability to estimated future revenues. Newly launched products have little historical data to use; thus, a run rate is ideal in forecasting sales.
Cons Explained
May be unreliable for companies with seasonal revenue: Seasonal revenue means the annualized numbers will be inaccurate because sales may vary from month to month. For example, let’s say a winter-sports-apparel company does more business in the winter than in the summer. If we were to use the sales numbers during a high-producing month to calculate the run rate for the business, it wouldn’t be reliable because we know that sales are only this high during the winter months. That annual run rate would likely be incorrect.Irrelevant for estimating one-off product sales: If a company decides to sell a product for only a short time frame with no plans of selling that product next year, then the run rate would be irrelevant since the product would not exist in the future.
What It Means for Investors
The run rate can help you determine if a company will likely be profitable in the long term. This may be helpful in deciding whether or not to invest in a company. If you calculate the run rate and it shows the company will bring in revenue, you may want to invest in it early to profit from that success. Since run rate is most applicable to newer companies, though, you’d likely be investing in a startup. The run rate is just one component in deciding if the business will be profitable, so be sure to weigh all of the risks, and never invest money that you can’t afford to potentially lose.
