Accounting Rate of Return Calculator

Accounting rate of return is an accounting-based evaluation method of an investment and is used to measure the return on investment. This calculator is designed to calculate the accounting rate of return of a specific investment project.

When calculating the accounting rate of return online, you can enter: incremental income, incremental expenses, initial investment amount, final investment and number of years to calculate the profit and average rate of return.

How is the Accounting Rate of Return Calculated?

Accounting Rate of Return (ARR) is a rate used for an accounting-based assessment of an investment project. This rate is based on the accounting records of the investment project and helps to measure the return on investment. The Accounting Rate of Return is often used to assess the profitability of the investment and to make decisions. Here is the basic formula on how the Accounting Rate of Return is calculated:

In this formula

• Total Net Profit refers to the total net profit generated over the life of the investment. Net profit is annual net cash flows less depreciation and taxes.
• Initial Cost of Investment represents the total initial cost of the investment. This usually includes the purchase cost of the investment.

This formula shows the profitability of the investment as a percentage of the net profit generated by the investment compared to the initial cost of the investment. A high Accounting Rate of Return may indicate that the expected return on investment is high. However, using this ratio alone provides a limited assessment. Combining it with other financial metrics and methods often provides a more comprehensive analysis.

What is the Accounting Rate of Return?

The Accounting Rate of Return (ARR) is a rate used for an accounting-based assessment of an investment project. It is calculated based on the accounting records of the investment and expresses the return on investment in percentage terms. The Accounting Rate of Return is used to assess the profitability of the investment project and is often preferred by accounting departments and managers.

The Accounting Rate of Return is calculated by dividing the total net profit over the life of the investment by the initial cost of the investment. This ratio provides a benchmark for determining the profitability of the investment and is based on the accounting records of the investment. The return on investment shows how much profit has been made relative to the initial cost of the investment.

A high Accounting Rate of Return may indicate that the expected return on investment is high, while a low rate may indicate that the expected return on investment is low or that its costs exceed the return on investment. However, using the Accounting Rate of Return alone provides a limited assessment and in combination with other financial metrics usually provides a more comprehensive analysis.

Accounting Rate of Return Formula

The formula for the Accounting Rate of Return is as follows:

Accounting Rate of Return = (Project Total Return – Project Total Cost) / (Project Total Cost) x 100

In this formula

• Project Total Return: refers to the total cash inflows generated during the project.
• Project Total Cost: the total cost from the beginning to the end of the project.

Example:

A company spends USD 100,000 on a business project. This project generated a total return of USD 150,000. To calculate the Accounting Rate of Return:

In this case, the project’s Accounting Rate of Return is 50%. This indicates that the project yields a return of 50% relative to its cost.

Uses of Accounting Rate of Return Calculation

There are various uses for the calculation of the Accounting Rate of Return. Here are some of them:

Evaluation of Investment Projects:

The Accounting Rate of Return is used to evaluate the profitability of different investment projects. When choosing between projects to invest in, companies can determine which project is more profitable by comparing the accounting rates of return of the projects.

Supporting Investment Decisions:

The Accounting Rate of Return is used to support the investment decisions of managers and business owners. The accounting rate of return of the project to be invested in shows the expected return of the project, which can be an important criterion in the decision-making process.

Budget Planning:

The Accounting Rate of Return can also be used in the budget planning process. By evaluating the accounting rate of return of a particular investment project, companies can determine how the project will fit into their budget planning.

Performance Evaluation:

Companies can regularly calculate accounting rates of return to monitor and evaluate the performance of existing investment projects. In this way, the profitability and performance of projects can be tracked over time and improvements can be made when necessary.

Investor Relations:

By sharing accounting rates of return with investors, companies provide investors with information about the company’s financial performance. High accounting rates of return can show investors that the company’s profitability has increased and is worth investing in.

These uses show that the accounting rate of return is an important tool for businesses and plays a large role in financial decision-making.

Advantages of Accounting Rate of Return Calculation

Here are some advantages of calculating the Accounting Rate of Return:

• Easy Applicability: Since the Accounting Rate of Return is calculated based on the accounting records of the investment, this data is readily available. Therefore, the calculation is usually easily applicable and can be performed quickly.
• A Clear Expression of Cost: The Accounting Rate of Return expresses the net profit achieved relative to the initial cost of the investment in percentage terms. This is a useful metric to get a clear understanding of the profitability of the investment.
• Contributes to Decision Making: Since the Accounting Rate of Return is used to assess the expected return on investment, it contributes to the decision-making process. Used to assess the profitability of investment projects, this ratio can help managers and business owners make the right decisions.
• Comparability: The Accounting Rate of Return can be used to compare the profitability of different investment projects. This can help determine which project is more profitable when choosing between alternative investment opportunities.
• Monitoring Financial Performance: Since the Accounting Rate of Return is based on the accounting records of the investment, it can be used regularly to monitor and evaluate the financial performance of the investment. This provides a useful tool to track the profitability and performance of the investment over time.

These advantages show that the Accounting Rate of Return plays an important role in the decision-making process and in the evaluation of investment projects.