About Accounting Rate of Return Calculator (Formula)
An Accounting Rate of Return (ARR) Calculator is a financial tool used in capital budgeting to evaluate the profitability of an investment or project. The Accounting Rate of Return is a method that assesses the expected financial return of an investment by comparing the average accounting profit generated by the project to the initial investment cost. The formula for calculating the Accounting Rate of Return is as follows:
Accounting Rate of Return (ARR) = Average Accounting Profit / Initial Investment Cost
Where:
- Accounting Rate of Return (ARR) is the percentage return on investment that the project or investment is expected to generate.
- Average Accounting Profit represents the average annual profit attributable to the investment. It is calculated by taking the difference between annual revenue and annual expenses (including depreciation) and averaging this amount over the investment’s useful life.
- Initial Investment Cost is the total cost of acquiring and implementing the investment, including any capital expenditures and initial setup costs.
The ARR is expressed as a percentage, making it easy to compare with other potential investments or projects. Generally, a higher ARR is considered more favorable, as it indicates a higher return relative to the initial investment.
It’s important to note that the ARR method is a simplified capital budgeting technique and has its limitations. It does not take into account the time value of money (discounting), and it relies on accounting profits, which may not always reflect the true economic profitability of an investment.
Accounting Rate of Return Calculators are valuable tools for businesses and financial analysts in assessing potential investments or projects. By calculating the ARR, they can make informed decisions about whether an investment is likely to generate a satisfactory return based on accounting measures. However, for more comprehensive financial analysis, other methods like Net Present Value (NPV) and Internal Rate of Return (IRR) are often used in conjunction with ARR.