The curious case of annual run rate (ARR)

Annual run rate is popular among sales professionals because it’s easy to calculate. But unfortunately, it isn’t always accurate—whether or not it’s reliable will depend on how consistent your company’s sales reporting is.

To help you better understand if ARR can accurately project your sales revenue, we'll take a look at:

• what annual run rate is,
• why it's not always reliable, and
• when to use it (and when you shouldn't)

Annual run rate (ARR) predicts future sales based on past earnings in a relatively short period of time, such as a month or a quarter. It assumes your revenue will be recurring, projecting that you’ll make the same number of sales or revenue in similar amounts of time in the future.

ARR is a basic equation that provides a quick way to get a picture of the amount of sales revenue, and annual recurring revenue, your company might make that year. However, it should be used carefully in projecting and planning because it often isn’t accurate. (More on this below.)

How to calculate your annual run rate

You can easily calculate ARR even if you’re not a math whiz.

To get started, decide if you’re going to work with monthly or quarterly figures, for annual recurring revenue. Count all your sales revenue during that amount of time (hopefully you’re using a CRM to quickly grab this data).

Then, use one of these two formulas to calculate your ARR:

See how simple?

Let’s run through a couple of examples of how to calculate ARR.

Say your company’s monthly sales revenue for January was $20,000. To find your ARR, you’d complete the following calculation:

• $20,000 * 12 = $240,000

Your ARR for that year would be $240,000.

While the simplicity in calculating annual run rate is nice, it’s actually too simple to get an accurate indication of what your annual sales revenue, and recurring revenue, may be. Because the calculation only considers one month or quarter of the year, it doesn’t factor in how things can change as time passes.

There are a number of factors that ARR doesn’t account for. Let’s take a look at them.

Annual run rate doesn’t account for good or bad months.

If the month or quarter you’re working from is particularly high or low, it can throw your entire projection off. This is particularly true for seasonal businesses that may not have consistent demand all year round.

Let’s use the following scenario as an example.

Say your sales team has a particularly strong month in August and brings in $30,000 in sales revenue. Using the ARR calculation from monthly revenue, you’d predict you’d have $360,000 in annual sales revenue.

This is significantly higher––$120,000 more to be exact––than the $240,000 we projected in the previous example.

Annual run rate doesn’t account for seasonal factors.

Many industries experience increased sales depending on the time of year––even if you don’t sell a seasonal item. Sales may spike around the holidays or even the New Year as people, such as an existing customer and new customer, are purchasing gifts or buying items to make their New Year’s Resolution more achievable.

The best way to determine if seasonal shopping, like with each existing customer and new customer, impacts your annual revenue is to look at past years. Identify if there is a pattern of high or low months and if certain events or holidays fall within that time. Then take a look at how much higher those periods are compared to other months. This should give you an idea of how strongly the seasons impact your sales.

Annual run rate doesn’t account for major company shifts.

It’s unlikely that your business will continue to operate exactly the same throughout an entire year. Your management may change, you may introduce new products, or you might change your pricing strategy.

Annual run rate also doesn’t account for any of this. If a new product does particularly well, your revenue could shoot up. On the other hand, if a new marketing strategy tanks, your sales could dip. Calculating your annual run rate, and finding valuation, with these numbers could dramatically skew expectations.

Although ARR might not be the most effective projection for sales revenue, and recurring revenue, it can still be a good metric to have on hand––it just needs to be used appropriately.

Let’s take a look at some scenarios where your ARR can come in handy, and some others where you’ll want a more specific sales revenue projection.

1. Use ARR if you’re a new business.

If you’re just getting your business off the ground, you might not have a lot of data to work from between you and any customer. Annual run rate might be one of the most accurate projections you can find at this time.

Your ARR can give you a sales target to work towards and help you create a sales goal for your company.

Say you sold $50,000 worth of products or services in your first quarter of business. Your annual run rate would be $200,000. Knowing this metric will help you stay on a path to creating consistent growth.

2. Don’t use ARR when talking to investors.

It can be tempting to show off your annual run rate to investors when you’ve had a particularly good month or quarter. Unfortunately, this could give them a false impression that you’ll have to answer to later down the road.

If you use ARR to project your annual sales revenue and then have a few bad months, you may not meet investors' expectations.

Instead of annual run rate, use a more specific projection when talking to company investors. Account for factors like churn, growth, and any product launches. While this revenue number might be lower, it will also be more accurate.

3. Use ARR if you’re newly profitable.

It’s not unlikely for a new company to have a few months (or even years) in the red. If you’re a newly profitable business, just like if you’re a new business, your annual run rate might be all you can project for future growth.

This is also true if you’ve made major changes to the company that significantly boosted profits, such as introducing a new product line or switching up management. Using annual run rate based on profits post-change can give you a better perspective of projected growth.

4. Don’t use ARR when creating a budget.

Budgeting is a complicated process––especially when you don’t know how much money you’re going to have to spend. However, when creating your budget, before your ARR calculation, you should still be as accurate as possible so you don’t end up over or underspending, which could lead to an unnecessary risk.

If you use annual run rate to project how much cash you’ll have to work with, you could find yourself in a situation you can’t afford.

Use a projection method that’s more stable, such as your sales revenue from previous years. Although there might be some changes that influence whether or not this number is accurate in the year to come, it’s a more suitable projection for budgeting.

5. Use ARR for sales rep goal setting.

One of the biggest benefits of calculating ARR is that you don’t need a huge algorithm, meaning sales reps can find their personal annual run rate quickly and easily. This is great for setting individual goals and objectives.

Let’s say a rep had a particularly solid month of sales. They’d like to know what their annual sales revenue would be if they continued on that path. ARR would be the perfect calculation to use.

This calculation can give your sales rep a number to work towards.

Many times, annual run rate is used to make a company’s sales revenue look better than it actually is. However, you shouldn’t discredit the metric entirely.

ARR gives you a quick and easy way to find a loose projection of your sales revenue for the year, making it a great calculation for setting goals or expectations. Your ARR can be used internally to see if your sales and reps are on the right path and if they’re growing.

Just remember that if you’re going to use your ARR, even if it’s only internally, you should be aware of factors that might influence your projected sales number. Look for any changes you’ve made to your strategy, product offerings, or shifts in the market that may have contributed to any increases or decreases.

At the end of the day, annual run rate should never be the sole metric you use to make significant decisions from. Instead, opt for something that considers other factors, shifts, and changes.