Businesses use a few key metrics to prove their financial health and potential to investors, lenders, and other stakeholders. Forecasting the financial future or long-term results of a business is essential for making the right business decisions. For a SaaS company, calculating your revenue run rate is a quick and easy way to understand and represent your business’s financial performance.
Revenue run rate is one of the simplest metrics you can use to forecast your company’s future cash flow. This calculation uses the revenue data you already have to estimate what your revenue for the entire year will be.
In this article, we’ll cover what exactly revenue run rate is, how you can calculate it, the limitations and pitfalls of using revenue run rate, and the situations where it’s most valuable.
As mentioned, revenue run rate is a very simple forecasting method for estimating your company’s annual revenue (the total amount of money you make in a year). It uses past financial performance to project future revenue. To calculate revenue run rate, you will use existing revenue data from a discrete period of time and convert it into an estimate of annual revenue.
To be clear, revenue and revenue run rate are not the same things. Revenue is a tally of the money you took in over a set time period. Revenue run rate is a prediction about future performance based on your existing revenue numbers. RRR is a quick way to forecast your annual revenue, even if you don’t have a full year’s data (or if your growth makes old data less relevant).
Let’s go over a quick example. Let’s say you have been doing business for one month, and you generated $1,000 in revenue. You could use the revenue data from that month to estimate your annual revenue by multiplying one month’s revenue by 12. In this case, your revenue run rate is $12,000.
You can then use your RRR to line up funding from venture or angel investors in an early-stage startup, or adjust your sales goals and strategy going forward.
How easy it is to calculate your revenue run rate depends on how much revenue data you have. Since we know there are twelve months in the year, using one month’s revenue makes the calculation very simple. But even if you have a less convenient starting point, you can still calculate revenue run rate with a simple formula.
Here are a few ways to calculate revenue run rate, starting with one month’s data.
One month’s revenue x 12 = Revenue Run Rate
If you have revenue data from your business’s first quarter, the revenue run rate formula is even simpler.
One quarter’s revenue (3 months) x 4 = Revenue Run Rate
But what if you have another data set? For instance, let’s say you had $14,000 in sales revenue over the past 75 days. Even though this short time period doesn’t fit neatly into months or business quarters, your revenue run rate formula only requires one more step.
First, divide your total revenue by the number of days over which it occurred.
$14,000 in revenue / 75 days = $186.67 daily revenue
Next, you multiply this daily revenue number by 365 to determine your revenue run rate.
$186.67 daily revenue x 365 days = $68,134.55
You can always fall back on this formula to determine your revenue run rate, no matter what period of revenue data you have.
(Total Revenue / # of Days in Period) x 365 = Revenue Run Rate
For a more detailed example, let’s consider Company X. They want to calculate their revenue run rate based on their past two months of data. In the past two months, they had $25,000 in revenue.
Because there are six two-month periods in the year, we can multiply that $25,000 by six and arrive at a revenue run rate of $150,000.
$25,000.00 x 6 = $150,000.00 revenue run rate.
This is the simplest way of calculating revenue run rate with this data. But another option is to use the daily revenue formula. If the revenue data is from March and April, that means we need to divide $25,000 by 61 days, which gives us $409.84 in daily revenue. Then, we could multiply that by 365 days to get a revenue run rate of $149,591.60.
$25,000 / 61 days = $409.84 daily revenue
$409.84 daily revenue x 365 = $149,591.60 revenue run rate
As you can see, just a slight change in how you calculate your revenue run rate can result in different numbers. That’s just one reason RRR is a very temperamental metric.
For another example, we can look at DocuSign, an eSignature and document management tool. The SaaS company reported that their revenue in the first quarter of 2021 was $469.1 million. To calculate DocuSign’s revenue run rate, we multiply that quarter’s revenue by four, which gives us $1.876 billion. In reality, however, Docusign achieved greater revenue in each quarter of the year, resulting in total annual revenue of $2.1 billion.
In this example, the revenue run rate was actually a conservative estimate, but that isn’t always the case. In the next section, we’ll see how other factors (that revenue run rate doesn’t consider) can make this a less accurate and reliable way of forecasting annual revenue.
Revenue run rate is an attractive tool for businesses and entrepreneurs because it’s so simple. If you can divide and multiply, you can calculate it. But there’s a reason companies don’t just calculate RRR and call it a day.
This metric’s biggest flaw is that it assumes everything will stay the same. And there are many factors that impact businesses that make it unlikely for revenue to stay constant for longer time periods.
Many businesses’ revenue fluctuates based on the time of year. As a result, if they calculated revenue run rate based on their busiest months, the run rate will be inflated. On the other hand, if they calculated using off-season data, their revenue run rate could be much lower than their actual annual revenue.
Consider H&R Block, the tax software and preparation company, as a prime example of why seasonal industries and businesses can’t rely on revenue run rate for a realistic estimate of annual revenue.
Their 2021 Annual Report notes that, given that most people file their taxes between February and April, “we generally operate at a loss through the first three quarters of our fiscal year.”
The rate of Google searches illustrates just how impactful seasonal fluctuations are.
If H&R Block calculated their revenue run rate based on data from February, the estimate they arrived at would be wildly inflated. Conversely, if they calculated RRR based on revenue numbers from the summer, the annual revenue estimate would be far below accurate.
This is one reason why businesses within industries prone to seasonal fluctuations sometimes calculate with quarterly revenue run rates.
Even businesses with more consistent demand will face fluctuations based on current events. The coronavirus pandemic is just one example of how world events can drastically change the economy and affect industries. No one anticipated that toilet paper would suddenly become a hot commodity in the spring of 2020.
Conversely, rising gas prices have been shown to lead to increased demand for smaller, more fuel-efficient vehicles. Many other industries are at the whim of public opinion and popular trends. The volatility of your industry will impact whether RRR is an appropriate method of financial performance forecasting.
Of course, a company’s own actions can also make past revenue data less relevant in predicting annual revenue. If your company releases an exciting new product with a lot of buzz, your actual annual revenue may be higher than what you calculated using revenue data from before the release. Pricing model changes can affect the efficacy of revenue forecasts, both by changing the revenue earned through consistent sales or by increasing or decreasing sales. Even improving yourbilling process efficiency could significantly affect your revenue.
For any subscription-based business (including software as a service), customers discontinuing their membership or subscription can take a huge bite out of your forecasted revenue. For instance, if you have multiple large accounts that cancel your service, the revenue data you used in your run rate calculations would become obsolete. Consider calculating your churn rate to forecast how this factor will affect future performance and revenue.
Or, if you don’t want to crunch numbers manually in spreadsheets, you can use a tool like Chargebee that provides these insights automatically. Our Churn Watch dashboard helps you track crucial customer and revenue churn metrics in real time.
Even with all these potential pitfalls, there are still valuable use cases for revenue run rate. As long as you recognize the metric’s limitations, RRR can be a valuable tool in the following situations.
Revenue run rate can be helpful for early-stage companies that don’t have a great deal of revenue data. If you don’t have a full year’s actual revenue, revenue run rate may be your best stand-in as you prepare for valuation and other milestones. Just keep in mind that your limited data is unlikely to remain truly constant. But revenue run rate is still better than empty guessing since it’s rooted in some actual data.
Many startups experience rapid growth in their early years or may weather several periods where they “scale up.” When anagile company is scaling, data from just a few months ago can become an inaccurate representation.
If your revenue has shot up over the last three months, you can use that data to generate a revenue run rate that may better forecast your revenue than if you calculated using the past year’s revenue data. Just remember that companies’ growth rates are often inconsistent and what you assume is growth could just be an anomaly.
Remember how changes in pricing or services as well asproduct experimentation can affect your revenue? Revenue run rate is actually an effective way to measure the effects those changes have on your business. You can use data from before and after a change to see whether the RRR was positively or negatively affected.
For example, if you change a part of the sales process and the RRR improves, it might be evidence that the change was an improvement that you should stick with. Of course, your revenue is affected by many different factors and so comparing RRR before and after a change is not a perfect test.
Both marketing and research and development (R&D) are essential to the success of a software as a service company. The trouble is that neither provide immediate return on investment. This makes it difficult for businesses to properly budget for these expenses. Revenue run rate can be useful in this case because it is a very conservative revenue estimate for a growing SaaS company.
For instance, if your company’s revenue has been growing steadily quarter over quarter, a RRR based on your past three months will likely be less than your actual annual revenue. By using this conservative revenue estimate while budgeting for marketing and R&D, a business is unlikely to overspend. For SaaS companies, RRR can serve as a guardrail against overly optimistic budgeting.
Revenue run rate is sometimes called sales run rate, annual run rate, annual revenue run rate, or even annualized revenue run rate. Besides these terms, there are also several other revenue metrics it could be confused with. Here, we’ll explain a few of these other metrics and how they differ from RRR.
Annual recurring revenue is a measure of how much revenue you can expect in a year, based on the annual subscriptions or memberships you have. It consists of the total subscription revenue you receive in a year, minus the revenue lost due to cancellations.
For instance, consider a SaaS company that charges $12,000 per year and has 1,000 annual contracts, their annual recurring revenue would be $12,000,000. As long as their number of clients remains the same, that’s how much subscription-based revenue they can expect to make in a year.
Most helpful for SaaS businesses and others using asubscription business model, annual recurring revenue is another metric whose accuracy depends a great deal on churn.
One of the ways ARR differs from revenue run rate is that it deals specifically with recurring revenue (most often subscription-based). If the same SaaS company also offers other products or services (like short-term consultations or hardware, that revenue would not be included in ARR. Because revenue run rate is based on total revenue over a given time period, RRR would include that additional income.
If the SaaS company has revenue data for August, in which they collected their usual subscription fees but also collected $75,000 for professional services, their RRR would reflect that.
To calculate their revenue run rate, you would multiply the month’s total revenue by 12 to get an RRR of $12,900,000.
$1,075,000 x 12 = $12,900,000 revenue run rate.
This would mean that the ARR would differ from the RRR by $900,000.
The nature of your business and they types of revenue you collect will determine which of these metrics are most useful.
Like annual recurring revenue, monthly recurring revenue is a measure based on subscriptions or membership fees. Therefore, it’s also well-suited for subscription companies or SaaS businesses. The difference between the two is that monthly recurring revenue is a measure of your expected monthly revenue, as opposed to an annual basis.
One way to think about monthly recurring revenue is like a salaried job. You expect to make a certain amount each month and will budget accordingly. Annual recurring revenue would be similar to your annual salary. Like a salary, recurring revenue is based on existing agreements between two parties, but there’s still the chance that the arrangement could be ended.
Forecasting revenue is always a tricky task. There are so many factors that can impact revenue positively and negatively. Nevertheless, predicting your revenue in the future is an important part of managing a company, budgeting, fundraising, and more.
If you want to forecast revenue for a very new company with little data or evaluate changes, revenue run rate is an easy way to estimate your revenue for the next year. The simplicity of calculating RRR makes it attractive but can also make it unreliable. If you keep in mind the limitations of revenue run rate, however, it can be a valuable tool in planning for the future.