Calculating your business' multi-year return expresses your overall profit during that period, but that figure's usefulness is limited to a single period's snapshot. A better expression of profit is converting the multi-year return to an annualized return, which expresses this multi-year return as if it spanned a single year.
Multi-Year Returns
A multi-year return is one of the simplest calculations, suggests Corporate Finance Institute, but also one of the most limited. This figure tells you what your total profits are over an extended period of time, but it doesn't enable you to compare investments or returns from differing lengths of time. The return is typically expressed as a percentage of your original investment, but can also simply convey a dollar value.
Calculating Multi-Year Returns
When expressed as a dollar value, a multi-year returns describes the amount of profit made over several years. As an example, if you made $10,000, $15,000 and $15,000 in three consecutive years, adding those figures produces a total return of $40,000. Dividing this total by your original investment and multiplying by 100 converts the figure into a percentage. Continuing with the example, if you originally invested $100,000 in the company, divide $40,000 by $100,000 and multiply by 100 to calculate a multi-year return of 40 percent.
Annual Rate of Return Definition
Annualized returns express periodic returns as an equivalent one-year value. This figure enables comparison between other investments’ annual returns, because the periods are the same. It also enables you to project your company's profits into the future, under the assumption that historic growth will be similarly sustained. Calculating the annualized return from a multi-year return takes into account annual variation, so the resulting figure more accurately represents your company’s performance, reports Indeed.com.
Calculate Annual Rate of Return
Converting a multi-year return into an annualized one effectively reverses the compound interest formula to back it up to a single year. However, this calculation uses the same formula, but the time period is a fraction of the multi-year period, such as 1/3 to represent a single year out of a three-year period. Adding 1 to the multi-year decimal return and raising it to the power of this fraction gives you the annual multiplier. Subtracting 1 from the result and multiplying by 100 converts the multiplier into the percent annualized return.
In the previous example, adding 1 to 0.40 and raising it to the power of 1/3 gives you a multiplier of 1.12. Subtracting 1 and multiplying by 100 gives you an annualized return of 12 percent.
The Average Return Calculator can calculate an average return for two different scenarios. The first is based on cash flows, and the second calculates a cumulative and average return of multiple investment returns with different holding periods.
Average Return Based on Cash Flow
This calculator estimates the average annual return of an entire account based on the starting and ending balances as well as the dates and amounts of deposits or withdrawals.
Average and Cumulative Return
This calculator estimates the average annual return as well as the cumulative return for different investment returns with different holding periods.
Average Return
The average return is defined as the mathematical average of a series of returns generated over a period of time. In regards to the calculator, the average return for the first calculation is the rate at which the beginning balance concludes as the ending balance, based on deposits and withdrawals that are made in-between over time. The time value of money is accounted for, which is a theory that states that a dollar today is worth more than a dollar tomorrow. For the second calculation, the average return is the total return of the entire period (for all returns involved) divided by the number of periods. The time value of money is also accounted for here.
Average Rate of Return
The average rate of return (ARR), also known as the accounting rate of return, is the average amount (usually annualized) of cash flow generated over the life of an investment. ARR does not account for the time value of money. As a result, it is best to use ARR in conjunction with other metrics when considering large financial decisions.
Both calculations above take into account the time value of money when computing the average return. Both average return and ARR are commonly used methods of determining relative performance levels.
Cumulative Return
Cumulative return refers to the aggregate amount an investment gains or loses irrespective of time, and can be presented as either a numerical sum total or as a percentage rate. It is generally contrasted with annual return, which is the return (or loss) of an investment in a single year only. The cumulative return should also be distinguished from the average annual return, which is the total of all the returns in a given period normalized annually.
Because most financial formulas revolve around and are presented in annualized figures, cumulative return as a metric is less commonly useful due to the lack of meaningful comparisons. Similar to ARR, cumulative return is best used in conjunction with other measures of performance.