Patrick Louie

Earning profits is the primary purpose of starting and running a business.

But first, to earn such profits, a business will have to earn revenue.

For a newly formed business, there is this uncertainty about whether it would earn revenue or not.

And if it will, how much will it earn?

Since the business is yet to finish a fiscal period, it doesn’t have any previous revenue data to base its future revenue.

Thankfully, there’s a certain metric that can address this very issue.

The metric that I’m referring to is the revenue run rate (a.k.a. run rate, sales run rate).

What it basically does is that it annualizes the current data.

For example, a certain business earns \$150,000 for the first quarter.

By using the revenue rate, the business forecasts that it will earn a total of \$600,000 in revenue for the year.

The simplicity of its calculation is what makes the revenue run rate useful even for businesses that have only begun operating.

They don’t need a previous year’s revenue data to make use of the revenue rate. In some cases, they only need the weekly revenue data.

What is it?

How can it help a business?

What are its uses?

How does one calculate a business’s run rate?

We will try to answer these questions as we go along with the article.

## What is the Revenue Run Rate?

The revenue run rate (a.k.a. run rate, sales run rate) is a financial performance indicator that annualizes a business’s current revenue.

It’s a metric that uses the business’s current revenue data to forecast its financial performance for a certain period.

For example, let’s say that a business earns \$5,000 for its first month.

Using the revenue run rate, the business forecasts that its annual revenue will be \$60,000.

To better understand the process of calculating the revenue run rate, let’s take a look at its formula:

Revenue Run Rate = (Revenue in Period ÷ No. of Days in Period) x 365

-or-

Revenue Run Rate = Revenue in Period x No. of Periods in a Year

Here, the period could be weekly, monthly, quarterly, etc.

Due to the simplicity of its calculation, the revenue run rate can even be useful for a business that is just beginning its operations.

It can even turn into a powerful tool if the business is confident that the financial environment that it belongs to won’t drastically change.

In some cases, a business might be able to secure funds based on its revenue run rate.

Do note that since the revenue run rate extrapolates a business’s current financial data and performance, it assumes that there will be no significant changes in the business’s financial environment in the future.

It assumes that whatever is the present financial environment will not drastically change in the future.

This leaks the revenue run rate’s weakness in that it’s not suitable for businesses that have erratic earnings patter such as those that earn more or less depending on the season.

## The Advantages of Revenue Run Rate

The simplicity of the revenue run rate’s calculation is one of its draws.

This simplicity allows it to even be useful for businesses that are only currently operating for a short period.

Here are other benefits of calculating the revenue run rate:

### Provides an estimate and benchmark for earnings

The revenue run rate is a business’s annualized earnings based on its current revenue data.

With its simple and fast calculation, a business can have an idea of what it’ll ultimately earn for the year.

However, this is assuming that the business is able to earn revenue at a relatively same level throughout the year.

### Helps in inventory management

If a business is able to make an accurate revenue rate calculation, it’ll know how and when it should restock.

An accurate revenue run rate can reduce the chance of overstocking or understocking which can lead to unnecessary expenses or losses.

### Adjust budget based on revenue run rate

Budgets are usually created before the operating year starts.

Thus, they may fail to account for items that are unpredictable.

On the other hand, the revenue run rate is calculated using current revenue data.

Thus, it can account for those items that the budget wasn’t able to.

With the revenue run rate, you would know which sections of the budget will need interim adjustments.

Be wary of both lower and higher-than-average revenue run rate figures.

Especially ones that are abnormally low or high.

This could be due to one-time sales, market trends, seasonality, etc. which may not always reflect in the next period’s performance.

## The Disadvantages of Revenue Run Rate

While the simplicity of the revenue run rate’s calculation is one of its draws, it’s also one of its drawbacks.

The formula fails to account for several factors such as seasonality, one-time sales, unexpected changes in financial performance, etc.

This often results in a revenue run rate that isn’t truly representative of the business’s performance for the period. It’s recommended to re-calculate the revenue run rate from time to time.

### Failing to account for seasonality

Some businesses within certain industries are naturally seasonal.

This means that their revenue will fluctuate depending on the season.

For example, a business may earn a higher-than-average revenue in December due to the winter holiday season.

Calculating the revenue run rate using revenue data from a period that is naturally high due to the season will result in an inflated revenue run rate.

It will usually not accurately represent the business’s financial performance.

On the other hand, using data from a slow season will result in an inaccurate low revenue rate.

Due to this, the revenue run rate isn’t suitable for seasonal businesses.

### Failing to account for changes in the financial environment

The calculation of the revenue run rate assumes that there will be no drastic changes in the future financial environment.

This is an often unrealistic assumption since the modern financial market is oftentimes unpredictable and volatile.

Thus, it’s not recommended to solely rely on the revenue run rate for revenue projections.

Changes in customer demand, supply, obsolescence, one-time sales, and legal and regulatory policies, among other things, can affect the financial environment.

### Failing to account for changes in financial performance

The calculation of the revenue rate typically uses the business’s current revenue data.

However, it does not account for events that could have caused changes in the business’s performance at a certain point in time.

For example, a tech business may be able to experience an increase in revenue due to a successful launch of a new product.

This increase in revenue isn’t always applicable for the following months after the launch because customers are less likely to buy duplicate units of a tech product.

Calculating the revenue run rate using the period in which revenue increased due to the successful launch of a new product will result in an inflated figure.

It will probably not represent the business’s performance for the year.

## Revenue Run Rate: Example

A new business earns \$7,500 in its first month of operations.

Roy, the business owner, wants to know how much the business will earn for the year.

Roy is confident that his business will earn the same level of revenue for the rest of the year.

We can help Roy by calculating the revenue run rate.

First, we know that the business earned \$\$7,500 for its first month. This will be our “Revenue in Period” value.

And since it’s monthly, the no. of periods in a year is 12:

Revenue Run Rate = Revenue in Period x No. of Periods in a Year

= \$7,500 x 12

= \$90,000

As per calculation, Roy’s new business has a revenue run rate of \$90,000.

Assuming that the business is able to earn the same level of revenue for the year, its actual annual revenue should be close to this revenue run rate figure.

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1. Warrington College Of Businesss "RATE OF RETURN: REGULATION " White paper. November 3, 2022