What is the 'Accounting Rate of Return  ARR'
The accounting rate of return (ARR) is the amount of profit, or return, an individual can expect based on an investment made. Accounting rate of return divides the average profit by the initial investment to get the ratio or return that can be expected. ARR does not consider the time value of money, which means that returns taken in during later years may be worth less than those taken in now, and does not consider cash flows, which can be an integral part of maintaining a business.
BREAKING DOWN 'Accounting Rate of Return  ARR'
Accounting rate of return is also called the simple rate of return and is a metric useful in the quick calculation of a companyâ€™s profitability. ARR is used mainly as a general comparison between multiple projects as it is a very basic look at how a project is doing.Calculation of Accounting Rate of Return
The accounting rate of return is calculated by dividing the average annual accounting profit by the initial investment of the project. The profit is calculated using the appropriate accounting framework including generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS). The profit calculation includes depreciation and amortization of project assets. The initial investment is the fixed asset investment plus any changes to working capital due to the asset. If the project spans multiple years, an average of total revenue per year or investment per year is used.
Accounting Rate of Return Example
The total profit from a project over the past five years is $50,000. During this span, a total investment of $250,000 has been made. The average annual profit is $10,000 ($50,000/5 years) and the average annual investment is $50,000 ($250,000/5 years). Therefore, the accounting rate of return is 20% ($10,000/$50,000).
Accounting Rate of Return Drawbacks
In addition to the lack of consideration given to the time value of money as well as cash flow timing, accounting rate of return does not provide any insight as to constraints, bottleneck ramifications or impacts on company throughput. Accounting rate of return isolates individual projects and may not capture the systematic impact a project may have on the entire entity â€“ both positively and negatively. Accounting rate of return is not ideal to use for comparative purposes because financial measurements may not be consistent between projects and other nonfinancial factors need consideration. Finally, accounting rate of return does not consider the increased risk of longterm projects and the increased variability associated with long periods of time.

Return
The gain or loss of a security in a particular period. The return ... 
Average Return
The simple mathematical average of a series of returns generated ... 
Yearly Rate Of Return Method
More commonly referred to as annual percentage rate. It is the ... 
Target Return
A pricing model that prices a business based on what an investor ... 
Annual Return
The return an investment provides over a period of time, expressed ... 
Expected Return
The amount one would anticipate receiving on an investment that ...

Managing Wealth
How To Measure Returns On The Series 65 Exam
An investor who is evaluating the performance of a portfolio manager must take into consideration the impact that any contributions or withdrawals made by the investor will have on the overall ... 
A Guide on the RiskAdjusted Discount Rate
When a project or investment faces higher amounts of risk or uncertainty, it may be appropriate to utilize the riskadjusted discount rate. 
Small Business
Understanding the Internal Rate of Return Rule
The internal rate of return rule is a popular method used to compare investments or projects. 
Investing
Calculating Annualized Total Return
The annualized total return is the average return of an investment each year over a given time period. 
Investing
Explaining Expected Return
The expected return is a tool used to determine whether or not an investment has a positive or negative average net outcome. 
Investing
Projected Returns: Honing The Craft
Find out how to forecast longterm returns on the three major asset classes. 
Investing
How To Calculate Your Investment Return
How much are your investments actually returning? Find out why the method of calculation matters. 
Insights
What's a Real Rate of Return?
A real rate of return is an annual percentage investment return thatâ€™s adjusted for inflation, taxes or other factors. 
Investing
How to Calculate Required Rate of Return
The required rate of return is used by investors and corporations to evaluate investments. Find out how to calculate it. 
Investing
How to Calculate Required Rate of Return
Investors use the required rate of return to decide where to put their money, and corporations use it to decide if they should pursue a new project.

What is the difference between a company's annual return and its annualized return?
Understand the importance of calculating a company's annual return and its annualized return, and learn the differences between ... Read Answer >> 
What is the formula for calculating net present value (NPV) in Excel?
Understand how net present value is used to estimate the anticipated profitability of projects or investments and how to ... Read Answer >> 
How do you use the profitability index rule when scoping out a project?
Understand the parameters of the profitability index rule and how this rule is used in corporate capital allocation to determine ... Read Answer >> 
How much debt is too much when calculating capital budgeting?
Learn how companies determine how much debt is acceptable when funding a new project by using the net present value to estimate ... Read Answer >> 
What is the difference between profitability and profit?
Calculating company profit and profitability are not one and the same, and investors should understand the difference between ... Read Answer >> 
How is the expected market return determined when calculating market risk premium?
Find out how the expected market return rate is determined when calculating market risk premium and how these figures are ... Read Answer >>