What is run rate
Technically speaking, the run rate is a sales projection is an estimated calculation, using statistical techniques, that allows us to know the sales forecast of a company in a future period of time.
We can consider it as a metric that indicates the future performance of a company based on past data. Its calculation is based on monthly or quarterly revenue figures, which are extrapolated to obtain forecasts for longer periods, such as annually.
The run rate is one of the best tools for evaluating and projecting annual financial performance. On many occasions, this information is very useful for young companies that do not yet have reliable historical data to analyze.
Also, companies that grow rapidly in short periods of time can make good use of it, as they could base their forecasts on the run rate of a specific growth period, instead of going back to old data.
Functions
Calculating the run rate is used to project and estimate a company's financial performance based on current data. With this forecasting tool, the company obtains a revenue projection and, in turn, the future scenario that will allow strategic decisions to be made.
It also allows the organization to analyze its growth, since it has an updated parameter to compare with previous results, evaluating whether the entity has grown, maintained or decreased financially.
In addition, thanks to this metric, the company can evaluate its expenses, analyze the efficiency and profitability of operations and identify opportunities in cost management.
Finally, this metric also enables and facilitates short and medium-term financial planning.
Calculating the run rate
The steps are simple:
Technically speaking, the run rate is a sales projection is an estimated calculation, using statistical techniques, that allows us to know the sales forecast of a company in a future period of time.
We can consider it as a metric that indicates the future performance of a company based on past data. Its calculation is based on monthly or quarterly revenue figures, which are extrapolated to obtain forecasts for longer periods, such as annually.
The run rate is one of the best tools for evaluating and projecting annual financial performance. On many occasions, this information is very useful for young companies that do not yet have reliable historical data to analyze.
Also, companies that grow rapidly in short periods of time can make good use of it, as they could base their forecasts on the run rate of a specific growth period, instead of going back to old data.
Functions
Calculating the run rate is used to project and estimate a company's financial performance based on current data. With this forecasting tool, the company obtains a revenue projection and, in turn, the future scenario that will allow strategic decisions to be made.
It also allows the organization to analyze its growth, since it has an updated parameter to compare with previous results, evaluating whether the entity has grown, maintained or decreased financially.
In addition, thanks to this metric, the company can evaluate its expenses, analyze the efficiency and profitability of operations and identify opportunities in cost management.
Finally, this metric also enables and facilitates short and medium-term financial planning.
Calculating the run rate
The steps are simple:
- Determine the revenues during a specific period.
- Determine the various periods occurring in a year.
- Multiply both figures.
Let's take an example:
A company generated €10,000 in revenue during the first quarter of the year (3 months). To calculate the annual run rate, and taking into account that there are 4 quarters in a year, we multiply the revenue by these time periods: 10,000 * 4 = 40,000 euros.
Situations to take into account
The following factors may hinder the measurement, accuracy and final usefulness of the run rate:
Seasonality
Seasonal variability has an impact on sales. Some months tend to have a higher volume of business and the run rate may or may not reflect these changes.
If, for example, the company generates more revenue in December and less revenue in August, the run rate with the December turnover will have nothing to do with the one obtained using August data.
Fluctuations in performance
Changes in the organization's performance can also impact the reliability of this metric. Circumstances internal or external to the company, from new competitors to a stockout, can alter the run rate calculation.
In short, the run rate assumes that the business is stable, although it is not really a constant situation. Any organization will experience better and worse times, with growth and losses, a fact that will condition the run rate calculations, depending on the figures used.
For all these reasons, it is a metric that should be applied with caution and a certain amount of skepticism. This method can provide valuable information on the evolution of the company, but it also provides a fairly approximate projection that is adjusted over time.
A company generated €10,000 in revenue during the first quarter of the year (3 months). To calculate the annual run rate, and taking into account that there are 4 quarters in a year, we multiply the revenue by these time periods: 10,000 * 4 = 40,000 euros.
Situations to take into account
The following factors may hinder the measurement, accuracy and final usefulness of the run rate:
Seasonality
Seasonal variability has an impact on sales. Some months tend to have a higher volume of business and the run rate may or may not reflect these changes.
If, for example, the company generates more revenue in December and less revenue in August, the run rate with the December turnover will have nothing to do with the one obtained using August data.
Fluctuations in performance
Changes in the organization's performance can also impact the reliability of this metric. Circumstances internal or external to the company, from new competitors to a stockout, can alter the run rate calculation.
In short, the run rate assumes that the business is stable, although it is not really a constant situation. Any organization will experience better and worse times, with growth and losses, a fact that will condition the run rate calculations, depending on the figures used.
For all these reasons, it is a metric that should be applied with caution and a certain amount of skepticism. This method can provide valuable information on the evolution of the company, but it also provides a fairly approximate projection that is adjusted over time.