The accounting rate of return is the volume of earnings or return, an individual can expect based on a contribution made. Accounting rate of return calculator divides the average profit by the initial contribution to get the ratio or return that can be expected. Account rate of return does not consider the time value of money, which means that returns taken in during later years may cost less than those taken in now, and does not consider cash progress, which can be an elemental part of maintaining a business.
Accounting Rate of Return Calculator
Accounting rate of return is also well-known as the simple rate of return and a metric is useful in the quick calculation of a company’s profitability. Accounting rate return mainly uses as a general comparison between multiple projects as it is the main look at how a project is doing.
Accounting rate of return determines by dividing the average of annual profit by the initial contribution of the project. The profit calculates using the applicable accounting framework is include generally accepted accounting principles or international financial reporting standards. The profit calculation includes depreciation and amortization of project assets. The initial contribution, the fix asset contribution plus any changes to working capital due to the asset. If the project period multiple years, an average of total earning per year or contribution per year use.
Accounting Rate of Return Example
The company is considering investing in a project that requires an initial contribution of $100,000 for some equipment. There will be the net progress of $20,000 for the first two years, $10,000 in years three and four, and $30,000 in year five. Finally, the equipment has a salvage value of $25,000.
First Calculate annual profit
|Inflows, Years 1 & 2
|Inflow, Year 3 & 4
|Inflow, Year 5||30,000|
(100,000 – 25,000)
|Total Profit of Project||15,000|
|Average Annual Profit
Second Calculate Average Contribution
Average investment = ($100,000 + $25,000) / 2 = $62,500
Third Divide Profit into Cost
Accounting rate of return = 3,000/62,500 = 4.8%
- Accounting rate of return is simple and straightforward to calculate.
- It focuses on accounting net operating Creditors and investors use accounting net operating income to calculate the performance of management.
- Accounting rate of return method does not take into account the time value of money. Under this method, a dollar in hand and a dollar to be received in future are considered of equal value.
- Cash is very important for every business. If a contributor quickly generates a cash progress, the company can contribute to other profitable projects. But accounting rate of return method focuses on accounting net operating income rather than cash progress.
- It does not remain constant over useful life for many projects. A business deal may, therefore, look desirable in one period but undesirable in another period.