What is revenue run rate?
Revenue run rate estimates how much revenue a company can generate over a certain period (typically a year).
The calculation is based on previously earned revenue. You can take your historical data, either monthly data or quarterly data, and then the revenue run rate you see is an indicator of your future financial performance.
How to calculate revenue run rate
Revenue run rate calculation is pretty straightforward.
Take your revenue in a period and multiply that by the number of periods in a year.
Example 1: ARR based on sales of the first quarter
Annual revenue run rate = revenue in a quarter x 4 quarters in a year.
For example, if you own a car dealership, your current data indicates that in your first quarter, you made $700,000. You now want to calculate your revenue for the year.
Based on the recent performance of a single quarter, your revenue run rate calculation will look like this.[($750,000 x 3] = $2,250,000
So based on your quarterly performance, your annual revenue run rate is $2,250,000
Example 2: ARR based on sales of the first half of the year
Let's continue with our car dealership example.
So, now half the year has passed and, unfortunately, the sales for your car dealership were less than expected. And now your ARR is slightly different. You earned a total of $100,000 for your second quarter.
Your ARR will look like [($750,000 + $100,000) x 2] = $1,700,000
As you can see, because a car dealership is a seasonal business, the different forecasted revenue run rate calculations paint two different pictures of the car dealership.
Limitations of revenue run rate
Revenue run rate is not always a good indicator to predict future financial performance. It has certain limitations.
Because it is a straightforward equation, the calculation fails to consider specific nuances, like seasonal fluctuations—no better example than the winter holiday season.
A retail company cannot base its forecast on holiday revenues such as Thanksgiving or Christmas, which would result in overestimating the revenue run rate. Conversely, it cannot base its revenue run rate on its January sales, which would understandably be lower after the holidays.
Startups or growing small businesses are always trying to increase future revenue. But if they based their sales forecasts on the revenue run rate, they would see discouraging results.
Airbnb famously only earned $200 per week. Based on their revenue run rate calculations, their annual revenue run rate would be $200 x 52 = $10,400. Luckily they did not shut down based on that forecast. Otherwise, they would have missed out on $1.5 Billion in revenue.
Your revenue run rate does not take into account customer churn. Customer churn can dramatically reduce your revenue. Let's say you are a saas company; if you will 5% of your customers next month (not a good sign), you lose your recurring revenue.
But since your annual run rate is based on your current month's sales, your revenue run rate predictions cannot account for churned customers. You will see a considerable discrepancy between forecasted and actual sales at the end of your forecasted period.
Not trusted by Venture Capitalists
If you want to raise funds from VCs and are preparing a pitch deck, do not use the annual run rate as a hook in your pitch.
Investors know that revenue run rate is not a helpful indicator of your company's financial performance. Sales can change significantly, especially if your company operates in seasonal industries. Therefore, using your revenue earned in a specific period as an indicator of future revenue potential is not a good idea.
Investors have seen all this before and are not likely to truly consider investing in your company if your out focuses too much on revenue run rate.
Benefits of calculating revenue run rate
While we admit that the annual run rate is not as reliable in predicting future performance, that is not to say you should never use the annual revenue run rate. There are some situations where it can prove helpful, especially if you do not have the resources for financial modeling.
Simple to calculate
Calculating the revenue run rate is simple and easy. If you are a new company and do not have a lot of financial resources or time to create a forecast, you can use this as a temporary forecasting method.
Set future performance goals for your sales teams
A new company can use the revenue run rate data to set a goal for its sales reps. You can create a target for your sales team, refer to the revenue run rate calculation, and, if needed, get back to the drawing board to think of new strategies to achieve your sales goals.
Increasing your revenue run rate
For new companies with no revenue data to analyze performance, revenue run rate is a great starting point. It can guide them to make decisions until they can rely on other metrics to report on their company's performance.
Upsell / Cross-sell current customers
Two methods to improve sales (and, by extension, your revenue run rate) are upselling and cross-selling.
As a small business, it's essential to keep your customers from churning; it's more expensive to find new clients than it is to retain current ones. So to increase your revenue run rate, start upselling/cross-selling to your existing customers.
Perhaps you can offer more tailored services and sell similar products to the one they purchased last time. (i.e., if you sell coffee machines and other brewing equipment, try to cross-sell some coffee filters rather than relying on one-time sales)
While this may seem obvious, reducing churn can help you maintain your revenue run rate, especially if you are a SaaS company.
Try to create a community around your product, customers that feel community belonging are less likely to churn.
Alternatively, you can focus on providing stellar customer service.
Customers are less likely to be price sensitive and churn and more likely to stay loyal if they receive excellent customer service.
Check out this blog post on Hubspot for more tips on reducing churn.