Accounting Rate of Return Calculator

| Added in Business Finance

What is Accounting Rate of Return and Why Should You Care?

Have you ever wondered how to determine if an investment is really worth your hard-earned money? Let's talk about the Accounting Rate of Return (ARR). It's like a more detailed cousin of your typical Return on Investment (ROI). While ROI gives you a basic idea of profit, ARR goes deeper. Why should you care? Because understanding ARR can help you make smarter investment choices by considering factors like working capital and scrap value.

Imagine going on a trip and not only budgeting for travel tickets (initial investment) but also your daily expenses (working capital) and what you could sell your travel gear for afterward (scrap value). It gives you the full picture!

How to Calculate Accounting Rate of Return

Calculating ARR might sound daunting, but it's quite straightforward. Here's the formula to get you started:

[ARR = \frac{\frac{\text{Registered Profit}}{\text{Years of Investment}}}{\frac{\text{Initial Investment} + \text{Working Capital} + \text{Scrap Value}}{2}} \times 100]

Where:

  • Registered Profit is the total profit made from the investment.
  • Years of Investment is the duration of the investment in years.
  • Initial Investment is the initial amount invested.
  • Working Capital includes current assets and liabilities required to keep the business running.
  • Scrap Value is the remaining value of an asset at the end of its useful life.

Calculation Example

Let's dive into an example of how to calculate ARR.

Imagine we're looking at an investment with these details:

  • Registered Profit (RP): $120,000
  • Years of Investment (YI): 4
  • Initial Investment (II): $150,000
  • Working Capital (WC): $30,000
  • Scrap Value (SV): $20,000

First, calculate the average annual profit:

[\text{Average Annual Profit} = \frac{\text{RP}}{\text{YI}} = \frac{120,000}{4} = 30,000]

Next, calculate the average investment:

[\text{Average Investment} = \frac{\text{II} + \text{WC} + \text{SV}}{2} = \frac{150,000 + 30,000 + 20,000}{2} = 100,000]

Now, plug these values into the ARR formula:

[ARR = \frac{30,000}{100,000} \times 100 = 30]

The result is expressed as a percentage.

The ARR for this investment is 30%.

Understanding Your Results

Are you starting to see why ARR is such a useful metric? It gives you a more comprehensive look at how well your investment is performing over a period of time, incorporating critical factors often overlooked by simpler calculations like ROI.

Understanding and using ARR can help guide your investment decisions more intelligently. Happy investing!

Frequently Asked Questions

While ROI measures the return based on the initial investment alone, ARR considers ongoing working capital and the end-of-life scrap value of assets, offering a fuller picture of profitability.

A higher ARR is generally better, but what is considered good can vary by industry and investment goals. Always compare ARR within similar contexts to make meaningful evaluations.

Yes, if the registered profit is negative, the ARR will also be negative, signaling a potential loss-making investment.

Higher working capital lowers ARR, while lower working capital increases ARR, assuming all other factors remain constant.

Including scrap value gives a more accurate assessment of profitability, as it takes leftover asset value into account at the end of the investment period.