What’s your Run Rate?
If you think I’m asking you how fast you can run a mile, then make sure you keep reading. 😁
And if financial forecasting is old news for you, just hold on a sec before you judge whether or not you should take the effort to read this.
It’s one thing to know what a term is and another to implement it practically into your company’s routine and rhythms.
My goal here is that by the end of this blog you not only know what your run rate is, but you also know how to consistently be aware of it.
What is Run Rate?
Run rate is a simple and quick way to help you forecast your financials. It looks at what you have done in the past (revenue, profit, expenses, etc.) and replicates it moving forward into the future for the rest of the year. Essentially, anything could have a run rate, but here the main thing we care about is the run rate of your revenue and your profit. It tells you how your business will perform at the end of the year if everything stays the same as it is right now. Even though we know nothing ever stays the same, it’s still valuable because it shows you what pace you are on.
How Run Rate Can Help You
There are a number of ways run rate can help you.
Here are three:
It helps you know what it feels like and what it takes to make $X amount of money by the end of the year.
Analysis: “If things keep going how they are, then I will make $X amount of money this year. The effort, time, stress, and work that I’m putting in is likely going to give me a return of $X.”
It helps you know if you are on track to hitting your financial targets and goals.
Analysis: “At the end of the year I’m set to make $X in revenue but my goal was $X, which means I’m off by $X amount.
It helps you make informed business decisions. You can know how much you likely should budget for spending and hiring for the rest of the year if things continue as is.
Analysis: “If I bring in this much money then I will be able to afford to hire that position because there should be enough money if everything keeps going as it is.”
Let’s take a look at a quick example to lock it in.
Example: It is June 2023 right now. I’ll use round numbers so it’s easier to follow. Let’s say your company has made $100,000 in revenue so far this year (Jan-May). To find the revenue run rate you simply take $100k and divide it by 5 (five months) to find your average monthly revenue of $20k. From there you multiply that by 12 (12 months in a year) to arrive at the total year-end value – the run rate. In this instance, the revenue run rate would be $240,000.
How To Pick Your Timeframe for Your Run Rate
There are a handful of ways to pick the timeframe for calculating your run rate:
Number of months into the current year
Trailing twelve months average
Past quarter data, etc.
Don’t overcomplicate it. Just pick a timeframe that is helpful and gives you some valuable data.
As with most things in finance, multiple angles help you hone in on the best analysis. If it’s February, then doing a run rate off of just January data might not be that helpful. Yet, that doesn’t make the January run rate data irrelevant. It still gives you the perspective that if you keep doing what you did last month, then this year is going to look like X. That’s helpful. It’s just not probably that accurate. It’s more of a gauge than anything else. I doubt that what you did in January and the run rate that projects for the whole year will actually be where you end up at the end of December. So calculate another run rate based on Q4 of the previous year and see where that comes in. Are the two calculations close? Maybe, maybe not. Either way, they give you some perspective.
Caveats to Run Rate
As with anything in financial analysis, no metric is perfect. Don’t rely solely on run rate for your forecasting. Use it as one of several forecasting methods you incorporate into the financial management of your company.
Here are some of the shortcomings of run rate. They are pretty intuitive.
History doesn’t usually replicate itself perfectly into the future. Just because you had a few months that went a certain way doesn’t mean that the rest of the year will go the same.
Seasonal businesses (like retail with holiday surge spending or lawn mowing in the summer) have large fluctuations in revenue over the course of the year. This type of business will need to rely more on past averages and nuancing the high season and low season forecasting so that they are realistic.
It doesn’t account for new products or services being launched. If you are a lawn mowing company and this year you decided to roll out a snow removal service in the winter months, then you will likely need to adjust your run rate to the upside to bake in this new revenue stream.
It doesn’t account for changes in the economy. If the economy drops into a recession, then it isn’t likely that your run rate projection will hold up.
Awareness Is Key To Growth
Okay, now you know how to calculate run rate, the benefits it can give, and how to safeguard against its deficiencies. Now you need to see this number often. You need to make this number easy to come across. Get it out of Quickbooks and spreadsheets and have it look at you consistently.
Put it on your fridge.
Write it on a post-it note.
Write it on your whiteboard.
Why? Because otherwise its just another number. Know the number. Tend to it. Update it when the next month closes.
If you don’t like what the run rate is projecting, then it might just motivate you to do something about it. Invest in your marketing. Start writing that blog. Roll out that new product line.
If you like the number it is projecting, then it might give you confidence that your are building something worthwhile. That the time, effort and energy you put out each week is making a difference. That maybe if you put a little more fuel on the fire you could really blow this thing up.
If you like the number, but it feels like your business is a little unhealthy and you are on the verge of burnout, then maybe you realize the input isn’t worth the output. Maybe you need to slow to a steadier pace and quit sprinting. Maybe you need to incorporate that lunchtime walk into your routine. Maybe you should book that vacation.
Run rate should be on your dashboard. It tells you if you are behind or ahead – and sometimes it can even tell you if you are overheating.
Calculate it, monitor it, and do something with what it is telling you.
More soon,
Lane
CONSULTANT + PARTNER
P.S.
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