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Revenue Run Rate

Annualized revenue

What is Revenue Run Rate?

Revenue Run Rate is an indicator of financial performance that takes a company’s current revenue in a certain period (a week, month, quarter, etc) and converts it to an annual figure get the full-year equivalent.  This metric is often used by rapidly growing companies, as data that’s even a few months old can understate the current size of the company. Another term for this is the Sales Run Rate.

In general, the run rate uses the current financial information, such as present sales and present revenue, to forecast performance. As it extrapolates the current financial information and performance there is an implied assumption that the present financial environment will not change significantly in the future.

 

revenue run rate timer

 

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Revenue Run Rate formula

Run Rate = Revenue in Period  /  # of Days in Period  x  365

 

The Revenue Run Rate takes information on present financial performance and extends it over a longer time period. Consider the following example: Company XYZ generates a revenue of $5 million in the first quarter of 2017. The company’s president wants to find out how much revenue his company is likely to generate for the rest of the year if conditions don’t change. He can use the Revenue Run Rate for this purpose. In this case, Company XYZ is operating at a Revenue Run Rate of $20 million a year.

When a company uses the data currently available to make projections about future financial performance for the whole year, the company is said to annualize the data. The above example is a case of annualization of data.

 

Why Do Companies use Revenue Run Rate?

Revenue Run Rate can be a very helpful indicator of financial performance for a young company that has only been in business for a short period of time. Revenue Run Rate can be an especially powerful tool if the company is relatively sure that the financial environment won’t change drastically.

Nascent firms can also quote Revenue Run Rate or Profit Run Rate figures when trying to raise funds for business activity. A company that doesn’t have a long established credit record might secure funds on the basis of their Revenue Run Rate. The Revenue Run Rate can also be helpful when a firm makes major changes to its operational structure and management. The Revenue Run Rate can be used as a benchmark to see whether the changes have improved the financial performance of the company or not.

 

The Risk of using the Revenue Run Rate

#1 Changes in environment

The Revenue Run Rate, like all Run Rate figures, makes the critical and often unrealistic assumption that the financial environment will remain relatively unchanged in the future. The modern world financial market is extremely unpredictable and fickle and making financial decisions solely on the basis of Run Rate type figures would be extremely foolish.

#2 Seasonality

In addition, even if we discount the threat of sudden changes to the financial environment, the Revenue Run Rate and other Run Rate type figures can be very deceiving.

Consider the case of seasonal industries. Retailers experience a massive rise in both Revenue and Profits in the month of December due to the winter holiday season.

If retailers such as Walmart and Target use the revenue and profit figures from this period to construct Revenue Run Rates or Profit Run Rates, then their estimates would be greatly inflated. On the other hand, if they calculated their Revenue Run Rate during a slower season of the year, not factoring in the Christmas rush would produce deceptively low figures.

#3 Changes in company performance

Revenue Run Rate and other run rate type figures are usually constructed based on the most recent available data and often do not account for events that could have caused a change in the financial performance of the company at a specific point in time.

For example, technology firms such as Microsoft, Sony and Apple tend to experience a rise in sales and revenue whenever they release a new product.

If such firms were to construct Run Rate type figures based only on data from the time period following the launch of a new product, then the data may be skewed.

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Revenue Run Rate – Example

In January 2017, cloud storage company Dropbox announced that it had passed $1 billion in Revenue Run Rate. Dropbox, based on the company’s own private valuation, is valued at $10 billion. Any future IPO would be affected by the Revenue Run Rate. Read more Dropbox’s run rate here.

 

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Applications in financial modeling

When building a financial model for an early stage company or a startup type, it is common to build a monthly forecast.  This then needs to be translated into annual terms, using the revenue run rate formula.  Learn more in our guide to startup valuation metrics.

 

 

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Related Readings

  • Revenue Recognition Principle
  • Effective Annual Rate
  • Forecasting an income statement
  • Financial modeling guide

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