00
Days
00
Hours
00
Minutes
00
Seconds
Cash flow at risk? 📉 Register for 'Top 10 common cashflow hurdles your clients face'
Register Now!

Futrli's guide to the Accounting Rate of Return (ARR)

Read our guide to the Accounting Rate of Return (ARR), why it is useful, and how to calculate it.

If you're making a long-term investment, it's critical to monitor your plans and budgets on a regular basis. The Accounting Rate of Return (ARR) is one of the most effective ways to measure the prospective profitability of an investment, making it a valuable tool for deciding which capital asset or long-term project to invest in. It is a great tool for making you a successful investor.

Two women in meeting
If you're making a long-term investment, it's critical to monitor your plans and budgets on a regular basis.

Helping to create successful investors

The Accounting Rate of Return (ARR) is the percentage return that may be expected from an investment or asset when compared to the original price of investment. ARR is frequently used in capital budgeting decisions because it allows you to evaluate whether continuing with a particular project, purchase, or another initiative is the right choice for your business's financial future.

The ARR formula is as follows:

  • ARR = average annual profit / average investment

How to put this into practice:

How you can calculate ARR

  1. Identify the annual net profit associated with your investment (the revenue remaining after operating expenses, taxes, and interest associated with implementing the investment or project)
  2. If the investment is a fixed asset, such as property, identify the depreciation expense
  3. Subtract the depreciation expense from your annual revenue figure
  4. You then divide the annual net profit by the initial cost of the asset or investment
  5. The result of this will be a decimal, so multiply the result by 100 to see the percentage return

There are ARR calculators that you can use online to double-check your figures and help your investment success.

Calculating ARR
There are ARR calculators that you can use online to double-check your figures and help your investment success.

Example

A business wishes to purchase new modes of transport for their employees. The purchase cost amounts to £350,000 and would increase the company’s annual revenue by £100,000, as well as the company’s annual expenses by £10,000. The modes of transport are estimated to have a useful shelf life of 20 years, with no salvage value. So, the ARR calculation is as follows:

  1. Average annual profit = £100,000 - £10,000 = £90,000
  2. Depreciation expense = £350,000 / 20 = £17,500
  3. True average annual profit = £90,000 - £17,500 = £72,500
  4. ARR = £72,500 / 350,000 = 0.2071 = 20.71%

The calculation shows that, for every pound that the company invests, it will receive a return of 20.71p. This is a good result and, considering external circumstances and other options, this may convince them to go ahead with the investment.

Someone giving presentation to team
You can use an Excel spreadsheet for ARR calculations.

Use Excel to calculate ARR

You can use an Excel spreadsheet for ARR calculations. Simply follow the steps below:

  1. In A1, write ‘Year’.
  2. In C1-G1, write 1, 2, 3, 4, 5 (assuming a five-year project).
  3. In A2, write ‘Net Income’.
  4. In C2-G2, write the net annual income for each year.
  5. In A3, write ‘Initial Investment’.
  6. In B3, write the initial investment for the project.
  7. In A4, write ‘Salvage Value’.
  8. In B4, write the salvage value, if any.
  9. In A5, write ‘ARR’.
  10. In B5, write =AVERAGE(C2:G2)/AVERAGE(B3:B4).
  11. Press enter to calculate ARR.
  12. ARR will now show in B5.

These details may need to be adapted depending on the specifics of your project. For example, your project may last longer than five years. Being able to calculate ARR can give you an idea of how much money your potential investment is likely to generate and thereby increase your risk tolerance.

Man on phone
Being able to calculate ARR can give you an idea of how much money your potential investment is likely to generate and thereby increase your risk tolerance.
Watch the Webinar Recording

Start Your Free Trial

Let informed predictions and powerful reporting guide your business. Be ahead of the curve with Futrli.

Get business advice here

Our blog holds tips, how to’s and general business advice.

Futrli News

Futrli's February 2024 Release

This is some text inside of a div block.

Heading

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Suspendisse varius enim in eros elementum tristique. Duis cursus, mi quis viverra ornare, eros dolor interdum nulla, ut commodo diam libero vitae erat.

Futrli News

Futrli's February 2024 Release

Accountants

3 Apps to beat accounting blues and scale your firm

Chris Downing catches up with three accounting app innovators to discuss the apps that they have developed that directly help accountants.

Accountants

Where most prediction software falls short

Tread carefully when looking for prediction software. Find out how to dig deeper into your predictions with the tools that count.

Small Businesses

Cash is King! 4 ways to keep your cash flow healthy.

Cash flow is essential to your business’ survival. Read our top 4 tips for taking control of your cash flow.

Small Businesses

10 Common Cash Flow Forecast Hurdles

If there’s one thing that all small and medium-sized enterprises should prioritise, it’s their cash flow. Read on to find out the top 10 most common issues.

Accountants

Empowering Accountants: How to Embrace Uncertainty with Futrli

The future is far from certain. Find out how Futrli helps accountants wade their way through murky, grey, “This might happen”-type scenarios.

Small Businesses

Inflation affecting your hospitality business? Take back control with these three steps.

Acting quickly is key to ensure you can ride out the incoming storm. Find out more in this article.

Small Businesses

Why cash flow forecasting helps businesses survive downturns in trade

Learn how cash flow forecasting is crucial for surviving slower trading periods.

Accountants

The 7 reasons why SMEs struggle with cash flow management

Find out the 7 major reasons why your clients’ businesses struggle to achieve a positive, healthy, consistent cash flow.

Accountants

Take clients from compliance to scenario planning in five steps

Scenario planning helps your clients imagine different environments or realities in the future, guiding the plans and decisions your clients make.

Accountants

Flash reports and why to build them

This short guide covers what Flash Reports are and how you could use them as a speedy solution for your clients’ reporting needs.

Small Businesses

Head of Accounting and Futrli COO discuss challenges and solutions for small businesses.

Read Dan and Helen’s thoughts on how SMEs can protect themselves during what is set to be a challenging year.