The term 'Run Rate' is included in the Accounting edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Check for lowest price here...
The Run Rate refers to a company or corporation’s financial performance. It utilizes the present financial information in order to forecast the firm’s future time frame performance. This then allows analysts and accountants to extrapolate going forward based upon the present day financial performance. Naturally this rate takes as a granted the belief that the current financial conditions for the economy in general and the firm in particular will continue. It is also possible for the run rate to mean the company’s average stakeholder ownership dilution on a yearly basis as a result of grants of stock options which the company has parceled out during the past three years and as featured within their annual report.
The idea of extrapolating such a future performance is based on the assumption that the current performance will indeed continue over the longer term. It always helps to consider a clear cut example to shed more light on difficult concepts like this one. If Nestle has sales of $10 billion in its last quarter, the Chief Executive Officer could reasonably extrapolate based on this data that the corporation is functioning on a $40 billion run rate. As such, the financial information is deployed in order to develop a year-long projection for the firm’s likely performance. Analysts would then call this process annualizing.
Run rates are often useful for coming up with good performance estimates for those corporations which have only a short corporate history behind them, as in under a year. Alternatively, they are particularly helpful for assessing the longer term extrapolations of new departments, divisions, or even profit centers in a well-established firm. This is often the case for any company that is enjoying its first quarter in profits in a long time or ever. This run rate can similarly prove to be useful if fundamentals in the operation of a given business were shifted in some meaningful way that will have a major impact on the future performance and results of the business in question.
The problem comes in with the run rate often proving to be an ultimately deceptive measurement. This is particularly the case in seasonal industries. A useful example pertains to retailers considering the profits in the wake of the important winter holiday season. This proves to be the crucial time period where a great number of retailers make their greatest volumes of sales. When such information is utilized to develop a run rate, then the resulting estimates of the future forecast will likely be flawed and over inflated.
Another weakness to the run rate is that it is usually dependent on only the most recent information. This means that it might not fairly compensate for changes in circumstances which can lead to a false bigger picture. With technology producers like Microsoft, Google, Samsung, and Apple, they often bring in far greater sales surrounding the launch of one of their new products. If they employ only the data from the time frame following a substantial product release, this will likely result in falsely skewed data.
Another limitation to run rates is that they do not take into consideration any big one-time only sales. It might be that a factory receives a big contract and is fortunate enough to be paid upfront for the order. Whatever their delivery timetable for the services or goods, this will lead to higher sales figures for a single reporting period because of this unusual one-off purchase.
It is easy to calculate up a run rate if the company has quarterly data. All that must be done is to multiple the numbers by four. When monthly data is being analyzed, the number has to be multiplied out by 12.