Comparisons: CAGR allows comparisons of growth rates across different time periods. You can compare the 3-year CAGR to the 5-year CAGR for example. You can also create quarterly and monthly growth rates. Investments: Investors use CAGR to evaluate historical returns and projected growth rates.
The compound annual growth rate (CAGR) is one of the most frequently used metrics in financial analysis and financial modeling. In financial models, the CAGR is calculated for important operational metrics such as EBITDA, and also for capital expenditures (capex) and revenue.
It's one of the most accurate ways to calculate and determine returns for individual assets, investment portfolios, and anything that can rise or fall in value over time. CAGR is a term often used when investment advisors tout their market savvy and when funds promote their returns.
Application in Business Strategy
CAGR helps in forecasting revenue growth, setting realistic goals, and assessing the viability of long-term projects. Meanwhile, AAGR offers a quick glance at steady growth patterns, assisting in short-term planning or performance assessment over consistent periods.
Disadvantage of CAGR: Smoothing and Risk
One disadvantage of the Compound Annual Growth Rate is that it assumes growth to be constant throughout the investment's time horizon. This smoothing mechanism may yield results that differ from the actual situation with a highly volatile investment.
Calculate the total number of years or periods over which the growth occurred. Use the formula: CAGR = (Ending Value / Starting Value) ^(1 / Number of Years) – 1. Multiply the result by 100 to express the CAGR as a percentage.
EBITDA will be higher than net income because it's the net income before taking out interest, taxes, amortization, and depreciation. While EBITDA is not necessarily “better” than net income, it is a better indicator of whether or not the business will be profitable.
Internal Rate of Return (IRR)
IRR is useful when cash is added or withdrawn at different times, like in real estate or project financing. Unlike CAGR, it takes into account uneven cash flows and the timing of when money comes in and goes out. IRR usually requires software like Excel to calculate.
Average annual growth rate (AAGR) is the average increase. It is a linear measure and does not take into account compounding. Meanwhile, the compound annual growth rate (CAGR) does and it smooths out an investment's returns, diminishing the effect of return volatility.
To calculate revenue growth as a percentage, you subtract the previous period's revenue from the current period's revenue, and then divide that number by the previous period's revenue. So, if you earned $1 million in revenue last year and $2 million this year, then your growth is 100 percent.
CAGR can also be used to calculate mean annualized growth rates on quarterly or monthly values. The numerator of the exponent would be the value of 4 in the case of quarterly, and 12 in the case of monthly, with the denominator being the number of corresponding periods involved.
What is the Rule of 72? Here's how it works: Divide 72 by your expected annual interest rate (as a percentage, not a decimal). The answer is roughly the number of years it will take for your money to double. For example, if your investment earns 4 percent a year, it would take about 72 / 4 = 18 years to double.
Yes, you certainly can. CMGR calculates average monthly growth, similar to CAGR, which calculates average annual growth rate. The formula for calculating CMGR is the same; simply replace the number of years with months.
For irregular investments with detailed cash flow data, XIRR is often more useful and accurate than CAGR since it accounts for the timing and size of all cash inflows and outflows. However, for regular investments focused on long-term growth, CAGR may be sufficient and easier to calculate.
The Rule of 40—the principle that a software company's combined growth rate and profit margin should exceed 40%—has gained momentum as a high-level gauge of performance for software businesses in recent years, especially in the realms of venture capital and growth equity.
A “good” EBITDA margin is industry-specific, however, an EBITDA margin in excess of 10% is perceived positively by most.
Revenue (sometimes referred to as sales revenue) is the amount of gross income produced through sales of products or services. A simple way to solve for revenue is by multiplying the number of sales and the sales price or average service price (Revenue = Sales x Average Price of Service or Sales Price).
CAGR is defined as the annualized growth rate in the value of a financial metric – such as revenue and EBITDA – or an investment across a specified period.
To smooth out this fluctuation, CAGR averages these variations and provides a single growth rate. This makes it easier for investors to compare the performance of different investments. Now, to calculate the CAGR, you must use this formula: CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1.
Usually, anything under an 8% CAGR is poor, but a good rate really does depend on the specific organisation. For example, companies who have been around for 10 or more years may see a CAGR of 8%-12% which is a good rate of sales for the amount of time they have been in business.
The most important limitation of the CAGR is that because it calculates a smoothed rate of growth over a period, it ignores volatility and implies that the growth during that time was steady. Returns on investments are uneven over time, except for bonds that are held to maturity, deposits, and similar investments.
For a developed economy, an annual GDP growth rate of 2%-3% is considered normal. Therefore, any GDP growth above the said rate is a strong sign that an economy is expanding and prospering. A prospering economy creates more wealth, which leads to increased spending.