Run Rate - Explained
What is a Run Rate?
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Table of ContentsWhat is a Run Rate?How Does the Run Rate Work?Uses for a Run RateRisks in Using the Run Rate
What is a Run Rate?
The run rate is a concept that describes the financial performance of a company by using the present financial information to predict what future performance would look like. The run rate gauges what the performance of a company would be in terms of finances if its current performance are extended or applied in the future. The run rate is the evaluation of a company's future financial performance on the assumption that its current performance would be extended into a future time.
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How Does the Run Rate Work?
The run rate gauges the future financial performance of a company on the precepts that its current financial performance performance would continue to a future time. When a company uses the run rate to measure its future financial performance, it means that an annual future financial projection is drawn by extending the current financial information over a longer time space.
Uses for a Run Rate
The run rate is important for a number of reasons, the major importance of the run rate are;
- The run rate creates an estimation of the future financial performance of a company by using current financial information to predict the likely future performance.
- Companies that have been in operation for a short period of time often benefit from this concept as it helps provide performance estimates.
- When a change is made in the departments of a business that can affect future performance, the run rate is useful.
Risks in Using the Run Rate
Despite the usefulness of the run rate metric, there are certain limitations or risks attributed to it. First, the run rate can be highly deceptive to seasonal industries because these industries experience significant financial performance in certain seasons and poor financial performance in other seasons. In companies like this depend on the run rate, it can cause chaos. For example, if a company that makes more sales during winter uses the current winter performance to gauge the future financial performance, there is a high tendency of financial failure. The run rate metric does not capture one-time sales or financial performance which is common to certain companies. Technological companies that experience higher sales when new products are launched can not use the run rate metric. Also, seasonal companies cannot rely on the run rate. Another limitation of the run rate is that it fails to capture the tendency of unplanned events to occur in a business, such as circumstantial changes. A circumstantial change can overturn the financial performance of a business, regardless of what the run rate looks like.