What is accounting rate of return?

Accounting rate of return (ARR) is a financial ratio used to evaluate the profitability of an investment or project. It is calculated by dividing the average annual accounting profit by the initial investment cost. ARR is expressed as a percentage and is used to assess the potential return on investment compared to the cost of the investment. It is a simple and easy-to-calculate metric that can help investors and managers make decisions about whether to proceed with an investment or project.

Accounting Rate of Return (ARR) is a financial metric used to evaluate the profitability of an investment or project. It is calculated as the ratio of the average annual accounting profit over the life of an investment to the initial investment cost.

Formula:

ARR = (Average Annual Accounting Profit / Initial Investment Cost) x 100

Key Points:

- ARR is a simple and straightforward measure of return.
- It does not consider the time value of money, unlike other methods like Net Present Value (NPV) and Internal Rate of Return (IRR).
- ARR assumes that the accounting profit is constant over the life of the investment.
- ARR is primarily used as a quick and easy screening tool to assess the potential profitability of a project or investment. However, it is not considered a precise measure of return and should be used in conjunction with other financial metrics.