Accounting/Average Rate of Return (ARR)

An Accounting/Average Rate of Return (ARR) is a financial ratio measure that calculates the financial return, generated from net income of the proposed capital investment.

• Context:
  • It can (often) be expressed as a percentage, reflecting the average annual return over the life of the investment.
  • It can (often) be defined as (Average Annual Profit) / (Initial Investment) x 100, where the average annual profit is derived from the net income over the investment period.
  • ...
  • It can range from being a Simple ARR (e.g. for small, short-term projects) to being a Comprehensive ARR (e.g. with financial analysis for larger investments).
  • ...
  • It can exclude considerations of time value of money, making it less accurate for long-term projects
  • It can be influenced by Depreciation Method choices (which can alter the net income calculation).
  • It can be used in Capital Budgeting to evaluate an investment's profitability by comparing the expected returns to the initial costs.
  • …
• Example(s):
  • ARR = 7%
  • …
• Counter-Example(s):
  • Net Present Value (NPV).
  • Internal Rate of Return (IRR).
  • Annual Recurring Revenue.
  • Annual Contract Value (ACV).
• See: Capital Budgeting, Time Value of Money, Revenue Run Rate, Profit Margin.

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References

2024

• (Wikipedia, 2024) ⇒ https://en.wikipedia.org/wiki/Accounting_rate_of_return Retrieved:2024-8-8.
  • The accounting rate of return, also known as average rate of return, or ARR, is a financial ratio used in capital budgeting. The ratio does not take into account the concept of time value of money. ARR calculates the return, generated from net income of the proposed capital investment. The ARR is a percentage return. Say, if ARR = 7%, then it means that the project is expected to earn seven cents out of each dollar invested (yearly). If the ARR is equal to or greater than the required rate of return, the project is acceptable. If it is less than the desired rate, it should be rejected. When comparing investments, the higher the ARR, the more attractive the investment. More than half of large firms calculate ARR when appraising projects. The key advantage of ARR is that it is easy to compute and understand. The main disadvantage of ARR is that it disregards the time factor in terms of time value of money or risks for long term investments. The ARR is built on evaluation of profits, and it can be easily manipulated with changes in depreciation methods. The ARR can give misleading information when evaluating investments of different size.

2023

• chat
  • The average rate of return (ARR) is a financial metric that is used to measure the average annual revenue generated by an investment over a period of time. ARR is calculated by dividing the total revenue generated by the investment by the number of years in the investment period.

    In the context of a SaaS company, ARR is often used to measure the company's annual recurring revenue. This is the revenue that a SaaS company generates from ongoing subscriptions or usage fees, rather than one-time sales. ARR is an important metric for SaaS companies, as it provides a reliable and predictable stream of revenue that can be used to plan and forecast future growth.

    For example, if a SaaS company has 1,000 customers paying an average of $100 per month for their service, their monthly recurring revenue (MRR) would be $100,000. If this revenue is sustained over the course of a year, the company's ARR would be $1.2 million ($100,000 per month x 12 months).

    SaaS companies typically aim to increase their ARR over time, either by acquiring new customers or by increasing the revenue generated from existing customers. By monitoring their ARR, SaaS companies can track their revenue growth and make informed decisions about product development, marketing, and sales strategies.

    Overall, ARR is a key financial metric for SaaS companies, as it provides a reliable measure of ongoing revenue generated by their service. By tracking and increasing their ARR, SaaS companies can build a sustainable business model and achieve long-term success.

2016

• (Wikipedia, 2016) ⇒ http://wikipedia.org/wiki/Accounting_rate_of_return Retrieved:2016-3-9.
  • Accounting rate of return, also known as the Average rate of return, or ARR is a financial ratio used in capital budgeting. The ratio does not take into account the concept of time value of money. ARR calculates the return, generated from net income of the proposed capital investment. The ARR is a percentage return. Say, if ARR = 7%, then it means that the project is expected to earn seven cents out of each dollar invested (yearly). If the ARR is equal to or greater than the required rate of return, the project is acceptable. If it is less than the desired rate, it should be rejected. When comparing investments, the higher the ARR, the more attractive the investment. Over one-half of large firms calculate ARR when appraising projects.

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