What is run rate in forecasting?

Published on Tuesday, October 22, 2019When you need to do revenue forecasting but you have limited information to go on, run rate revenue gives you a way to extrapolate from the da

What is run rate in forecasting?

Published on Tuesday, October 22, 2019

When you need to do revenue forecasting but you have limited information to go on, run rate revenue gives you a way to extrapolate from the data you do have. Run rate revenue is a sales forecasting method that takes the data you have available and projects it into the future to provide you with revenue estimates. This can be valuable if youre a new company with little historical data to go on, if your growth is outpacing your historic performance or if you have recurring revenue to use as a basis for extrapolation.

In this blog, well look at what run rate revenue is and cover three different ways you can calculate it in order to refine your projections for accuracy. Then well suggest five different ways you can apply run rate revenue to predict and manage your financial performance. Well also consider some limitations of using run rate revenue which you should be aware of when using this method. Finally, well look at how automation can provide you with instant, accurate, up-to-date run rate revenue data.

What is Run Rate Revenue?

A revenue run rate, sometimes called sales run rate or account 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 dont 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 doesnt 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.

How To Calculate Run Rate Revenue: Three Methods

There are a few different methods for calculating your revenue run rate, depending on the need to account for seasonality or time-based weighting.

1. Run Rate Revenue Formula #1: Exit Rate Method

For companies using a monthly subscription model, using the exit rate from the last months recurring revenue (MRR) is the simplest method.

Lets say a company earned $2M in monthly recurring revenue in December, plus another $1M in one-time sales for total monthly revenue of $3M. They arent 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 Decembers 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 companys cash flow and stability.

2. Run Rate Formula #2: Last Quarter Annualized (LQA) Method

Another common method for calculating run rate revenue, especially on an annual basis, is to annualize the last full quarters actual revenue. In other words, take the prior three months 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 months exit rate times 12.

3. Run Rate Formula #3: 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. Augusts forecast is calculated by taking the average of the six months from February to July.

How To Calculate Run Rate Revenue
How To Calculate Run Rate Revenue

How To Use Run Rate Revenue: Five Applications

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 using run rate revenue projections 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 isnt 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.

  1. 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, its reasonable to expect your earnings for one month will remain stable in future months.

    However, if you seek to exceed your run rate, youll want to increase sales for future months through promotions, advertising, or one-time sales.
  2. Get a quick look at your projected revenue, especially in a new company: The quick and easy calculations for run rate revenue lend itself well to gauging your companys 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.
  3. Adjust budget based on projected annual run rate revenue: Knowing your run rate revenue can help you allocate budget where its 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 dont pan out.
  4. Make business growth decisions: Can you afford new manufacturing equipment or capital improvements? Looking at your run rate revenue may help you decide.
  5. 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 dont overstock or run out of merchandise on a monthly basis.

Risks 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 companys 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 youre seeking financing, your run rate revenue wont 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 cant deliver.
  • Using run rates to budget can lead to overspending: An overly optimistic run rate can lead to overspending. This can create cash flow problems.

How to Automate Your Run Rate Revenue Calculations

Applying run rate revenue strategies is easier when you leverage technology to simplify your calculations. The outdated way to do this is by using spreadsheets. While you can use spreadsheets to tally up run revenue calculations, this method has several major drawbacks.

With spreadsheets, you have to import your data from other applications, which takes extra time and runs the risk of making mistakes. Moreover, data imported in this way typically is outdated by the time it gets into your spreadsheet. The process of setting up run rate revenue formulas in your spreadsheet takes additional time. Finally, once you have your data and calculations, if you want to view them, generate reports from them or share them with other applications, this requires additional steps.

A better approach is to automate all these steps by using an app designed for revenue operations forecasting. The revVana revenue operations platform has native Salesforce integration so you can sync your revenue data without the extra steps required when using spreadsheets. Your data and calculations based on it become available instantly to you and your team in real-time. You can automatically customize your calculations to reflect forecasts at the account level, sales territory level, or any other level you prefer. You dont have to go through the tedious task of setting up spreadsheet formulas and verifying that theyve been set up correctly. The information you need is instantly available for viewing and sharing. Plus, your revenue forecasting data integrates with your CRM app so it can support your sales strategy and planning. And if you do prefer a spreadsheet-style interface, you can still view your forecasting data in a spreadsheet view within Salesforce.

Use Run Rate Revenue Automation to Improve Your Financial Forecasting

Run rate revenue calculations let you extrapolate from your available data to project future revenue performance. This can be useful for new companies, growing companies, or businesses with recurring revenue.

You can use several different methods for calculating run rate revenue for refined accuracy. These include the exit rate method, based on last months recurring revenue; the last quarters annualized method, based on your previous three months; and the rolling average method, based on the average of select months.

Applications of run rate revenue include setting sales goals, projecting revenue quickly, adjusting your budget, making business decisions, and planning inventory management. When using run rate revenue, be aware that investors may not consider it accurate, and beware of the tendency to overspend based on overly optimistic projections.Run rate revenue represents 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. The revVana software platform integrates with your Salesforce CRM to ensure accurate run rate revenue figures for better revenue predictions. Reach out now for a free demo.

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