What is Accounting Rate of Return (ARR)?
The accounting rate of return (ARR) is a simple estimate of a project's or investment's profitability that subtracts money invested from returns without regard to interest accrual or applicable taxes.
How Does Accounting Rate of Return (ARR) Work?
Also called the 'simple rate of return,' the accounting rate of return (ARR) allows companies to evaluate the basic viability and profitability of a project based on projected revenue less any money invested. The ARR may be calculated over one or more years of a project's lifespan. If calculated over several years, the averages of investment and revenue are taken.
The ARR itself is derived from dividing the average profit (positive or negative) by the average amount of money invested. For instance, if the annual profit for a given project over a three year span averages $100, and the average investment in a given year is $1000, the ARR would be $100 / $1000 = 10%.
Why Does Accounting Rate of Return (ARR) Matter?
The ARR should be used as a method for quickly calculating a project's viability, particularly where compared to that of other projects. Nevertheless, the ARR's failure to account for accrued interest, taxation, inflation, and cash flows makes it a poor choice for long-range planning.