## What Is Accounting Rate of Return (ARR)?

Accounting rate of return (ARR) is a formula that reflects the percentage rate of return expected on an investment, or asset, compared to the initial investment's cost. The ARR formula divides an asset's average revenue by the company's initial investment to derive the ratio or return that one may expect over the lifetime of the asset, or related project. ARR does not consider the time value of money or cash flows, which can be an integral part of maintaining a business.

1:41

## The Formula for ARR

?$ARR = \frac{Average\, Annual\, Profit}{Initial\, Investment}$?

## How to Calculate Accounting Rate of Return

1. Calculate the annual net profit from the investment, which could include revenue minus any annual costs or expenses of implementing the project or investment.
2. If the investment is a fixed asset such as property, plant, and equipment (PP&E), subtract any depreciation expense from the annual revenue to achieve the annual net profit.
3. Divide the annual net profit by the initial cost of the asset, or investment. The result of the calculation will yield a decimal. Multiply the result by 100 to show the percentage return as a whole number.

## What Does ARR Tell You?

Accounting rate of return is a capital budgeting metric that's useful if you want to calculate an investment's profitability quickly. Businesses use ARR primarily to compare multiple projects to determine the expected rate of return of each project, or to help decide on an investment or an acquisition. ARR factors in any possible annual expenses, including depreciation, associated with the project. Depreciation is a helpful accounting convention whereby the cost of a fixed asset is spread out, or expensed, annually during the useful life of the asset. This lets the company earn a profit from the asset right away, even in its first year of service.

### Key Takeaways

• The accounting rate of return (ARR) formula is helpful in determining the annual percentage rate of return of a project.
• You may use ARR when considering multiple projects, as it provides the expected rate of return from each project.
• However, ARR does not differentiate between investments that yield different cash flows over the lifetime of the project.

## How to Use ARR

As an example, a business is considering a project that has an initial investment of $250,000 and forecasts that it would generate revenue for the next five years. Here's how the company could calculate the ARR: • Initial investment:$250,000