You should not have a hard time calculating your annual growth rate (AGR). Many business owners fail to check up on it because it can be confusing. In this post, we’ll walk you through how to calculate your annual growth rate the easy way. This way, you can always stay on top of your business growth and use the trends to inform your decisions. Your annual growth rate is a very important metric for maintaining business stability and your sanity, too!
What Is Annual Growth Rate?
Annual growth rate, also known as the average annual growth rate (AAGR) reveals the increase or decrease in value of individual company assets, cash flow, investments and other streams of income, whether they are passive or active.
You can do this on an annualized basis and can calculate it by finding the average or mean of each year’s return. This figure is usually represented by a percentage so that business owners and investors can visualize it more easily.
Why Is It Important to Calculate Annual Growth Rate?
Simply put, your average annual growth rate can tell you and your investors how well you are performing as a business. You can track the growth of your business and compare multiple years of growth. This way, you can see if you are trending upwards, are stagnant, or if your business is actually shrinking.
Your average growth rate per year is important because it informs other financial information needed for a comprehensive analysis of your financial standing as a business. It is a useful metric that can also inform your future business decisions.
If your average annual growth rate is lower this year as compared to the last year, check it out. Start with a deep dive into which areas may have caused that dip to happen. For instance, perhaps you noticed your average growth rate in one year was in the negative. You can start by looking at whether you sold as much product this year as you did the last. If sales were up, the dip could potentially mean that funds are spilling out in a different area of business operations. If so, that area needs better management or a more economical solution to cut costs.
How Do I Calculate My Annual Growth Rate?
To calculate the growth rate of a single year, you are dividing the value that you have at the end of that year period by how much you had at the beginning.
The formula for annual growth rate is:
ARG = (Value at the end of the year / Value at the beginning of the year) – 1
The answer is then multiplied by 100 to get the percentage value.
If you want to get the simple arithmetic average of multiple years of growth rates, the formula for average growth rate per annum is:
AAGR = Year 1 AGR + Year 2 AGR + Year 3 AGR (+ all other annual growth rate numbers you have available) / Number of years
Note: When you are calculating, make sure the periods of time you’re calculating for are all even. If it’s weeks, make sure they are all weeks. If it’s months, make sure they are all months, etc.
Growth Rate Example
Say you began your first year of business with a $50,000 investment. This will be your starting or beginning value. Let’s calculate your growth rate for 5 years of business.
Given Values:
- Starting value: $50,000
- End of Year 1 value: $55,000
- End of Year 2 value: $65,000
- End of Year 3 value: $80,000
- End of Year 4 value: $75,000
- End of Year 5 value: $85,000
Calculation Steps:
The first step is to calculate the growth rate of each year in percentages using the aforementioned formula. (We will round the percentages for the sake of this example.)
Year 1 End Value ($55,000) / Starting value ($50,000) = 10% growth in the first year
Year 2 End Value ($65,000) / Year 1 End Value ($55,000) = 18% growth in the second year
Year 3 End Value ($80,000) / Year 2 End Value ($65,000) = 23% growth in the third year
Year 4 End Value ($75,000) / Year 3 End Value ($80,000) = -12% growth in the fourth year
Year 5 End Value ($85,000) / Year 4 End Value ($75,000) = 13% growth rate in the fifth year
Now that we have the rates for all the years, we simply need to add all the percentages together and divide by the number of years to get the average growth rate that your business experiences year over year.
AAGR = 10% + 18% + 23% + -12% + 13% / 5 years = 10.4%
What are the Annual Growth Rate Restrictions?
There is an inherent volatility in investments. And the limitations of annual average growth rate calculations do not account for the fluctuations that occur within that year’s period between receiving the investment and calculating the end value. This means that through average annual growth rate, you cannot account for the risk of the investment as calculated by the volatility of the price. Basically, you can estimate your average growth rate per year, but not the potential risk involved.
Another limit of calculating the average annual growth rate is that it does not include compounding. That’s a separate calculation known as compound annual growth rate (CAGR). While AAGR can help you find the average growth of an investment within a series of years, you miss the fluctuations during those periods.
Another limitation is that growth rates can be over-exaggerated when there are positive and negative returns.
AAGR versus CAGR
The average annual growth rate is a linear measure. It does not take into account any of the effects of compounding. Your average growth rate calculated per year can help you to identify trends. This simple percentage cannot, however, give you a real picture of changing financials. The metric can therefore mislead you if you are not looking at any other data. Sometimes, for example, you can get an overly optimistic impression of how big your investment has grown.
Let’s look at the following example to see how this works.
Given Values:
- Beginning value = $100,000
- End of year 1 value = $120,000
- End of year 2 value = $135,000
- End of year 3 value = $160,000
- End of year 4 value = $200,000
Let’s say that you have an end-of-year value of $200,000 in your fifth year of business. And let’s say that you have calculated -50% for your percentage growth rate for that same year. You might then get an average rate of growth of 5.2% for those five years. This is not a clear idea of where your business it at, though. If you have the same beginning value for your first year of business and your last year of business, think about it. These numbers would clearly show you that your business performance has brought you a 0% return.
Note that the data that you need to be looking at will not always be the same. What you need to consider will always depend on your specific business situation. In some cases, you may actually find more helpful to you to calculate your compound growth rate per year instead of the much simpler average growth rate per year.
The compound annual growth rate gives you a more balanced picture of what your returns on investment are. This metric also smoothens out the effect of how volatile your business’s periodic returns can be. Again, this is on a case-by-case basis. You need to really consider what you are trying to figure out and then take the numbers that you need and do the appropriate calculations.
Formula for Compound Annual Growth Rate
CAGR = (Ending Balance / Beginning Balance) 1/Years – 1
If you look at the first four years of the sample numbers above, you will not see much of a difference between them. This means that the average growth rate that you will calculate per year for any number of years and the compound growth rate percentage for the same number of years will be nearly the same. If you add in the number for the fifth year, though, when you figure out your compound growth rate, it will come to 0%. This is a big difference from the calculated 5.2% for your average growth rate.
What Does the AAGR Tell You?
The average growth rate of any business as calculated over the number of years it has been in operation can reveal to you certain trends. Primarily, you will see valuable data in terms of your investment returns and cash flow in a long-term format. It shows you your average annual return through the years, but it does not take compounding into consideration.
Conclusion
As a business, you must always calculate your annual growth rate and update your average annual growth rate. This metric is so important to the survival of your business, both in the short term and over the long run. Your annual growth rate can directly impact how many years you stay in business. And the more years you stay in business, the more valuable data you can collect from your annual growth rate.
