Definition: Run rate refers to the estimation of a firm’s future performance based on its current financial data under the assumption that the present conditions of business will be the same in the future.
What Does Run Rate Mean?
What is the definition run rate? Run rate is the annualization of a firm’s financial data that pertain to monthly or quarterly results, seeking to make the data comparable. The RR may also refer to the average dilution of stock options for a certain amount of time.
Although the RR is used in several situations, it also incurs certain risks related to the projections it generates. For instance, there may be capacity constraints in the base period or reductions in the business expenses. Seasonality is also a factor that may cause the RR to project inaccurate results.
Let’s look at an example.
Company A is a new company that started operations 6 months ago. The manager wants to project the company’s annual sales and profits; hence, he is using the RR.
The company’s results for the first 6 months are sales $135,850 and net income $85,225. Using the run rate, the manager projects that by the end of the year, the sales will be $135,850 x 2 = 271,700, and the net income will be $170,450. Because the results are generated during the first 6 months, the manager assumes that the following 6 months the results will be the same.
However, as the business is a travel agency, it is highly likely that the sales and the net income will be more than double in the second six months of the year due to seasonality. For instance, from June to September as well as in December people are traveling more than what they do in February or in October. Therefore, using a run rate of double sales and net income, in this case, is not accurate.
Define Run Rate: Run-rate means a financial forecasting estimate of future performance based on current performance.