Denominator changes the headline
Switching from initial investment to average book value can almost double ARR when depreciation is heavy—same profit, different base.
Base flip
Accounting Rate of Return (ARR) Calculator
Inputs
Tip: Profit should be after depreciation (and typically after tax).
Results
Average accounting profit
£0.00
Investment base
£0.00
ARR
0.00%
Depreciation (per year)
£0.00
Investment base
Average profit
Tip: Press Ctrl/Cmd + Enter to calculate.
Formula
Accounting Rate of Return (ARR):
ARR = Average Accounting Profit ÷ Investment Base × 100.
The investment base can be the initial outlay or the average book value over the asset’s life under straight-line depreciation:
(Initial + Salvage) ÷ 2.
Detailed mode assumptions
- Straight-line depreciation:
(Initial − Salvage) ÷ Life. - Accounting profit ≈
(Revenue − Cash Expenses − Depreciation) × (1 − Tax Rate). - No financing/interest effects are modeled.
Informational only — not financial advice. Double-check results before making decisions.
What is Accounting Rate of Return (ARR)?
The Accounting Rate of Return (ARR) is a simple profitability metric used in capital budgeting. It expresses the average annual accounting profit from a project as a percentage of the investment base. Unlike cash-flow methods, ARR focuses on earnings reported in the income statement (after depreciation and typically after tax), making it easy to reconcile with financial statements and management reports.
ARR formulas used in this tool
Core formula: ARR = Average Accounting Profit ÷ Investment Base × 100.
The investment base can be defined in different (but common) ways:
- Initial investment (cost of the asset or project outlay).
- Average book value, often approximated under straight-line depreciation as
(Initial + Salvage) ÷ 2. - Custom base when a specific policy or course requirement applies.
In Detailed mode, the tool derives profit with straight-line depreciation:
Depreciation per year = (Initial − Salvage) ÷ Life.
Profit after tax is approximated as
(Revenue − Cash Operating Expenses − Depreciation) × (1 − Tax Rate).
In Simple mode, you can input the average annual accounting profit directly (useful when you already have a forecast or policy figure).
Worked example
Suppose an asset costs £10,000, has no salvage value, and a useful life of 5 years.
Annual revenue is £6,000; cash operating expenses are £2,500; tax rate is 25%.
Straight-line depreciation is £2,000 per year.
Profit after tax ≈ (6000 − 2500 − 2000) × 0.75 = 1,125.
If you use the initial investment as the base,
ARR ≈ 1,125 ÷ 10,000 = 11.25%.
Using the average book value base (here £5,000),
ARR ≈ 1,125 ÷ 5,000 = 22.5%.
The choice of base materially changes the percentage, which is why policies differ.
Strengths and limitations
- Pros: Quick to compute, easy to explain to non-finance stakeholders, aligns with financial statement profit.
- Cons: Ignores cash-flow timing and risk; can vary based on denominator choice; not a discounting method.
When to use ARR vs. NPV/IRR
ARR is ideal for early screening, performance targets tied to accounting profit, or comparing projects within the same policy framework. For investment decisions where timing of cash flows matters (e.g., property, infrastructure, multi-year programmes), complement ARR with NPV (net present value) or IRR (internal rate of return).
This material is for education only and is not financial advice. Always check your organisation’s policy (e.g., whether to use initial or average investment and whether profits are pre- or post-tax).
FAQ
What does “average accounting profit” mean?
Average annual profit after depreciation (and typically after tax) over the asset’s life—based on accounting earnings, not cash flow.
Which denominator should I use?
Policies differ. Many texts use initial investment; others prefer average book value to reflect declining book value under straight-line depreciation. This tool supports both.
Is ARR comparable across projects?
ARR is quick but time-agnostic. For cross-project comparisons with different timing, use NPV or IRR.
5 Fun Facts about ARR
ARR is time-blind
Front-loaded and back-loaded profit streams with the same average profit show identical ARR, even if their NPVs or IRRs diverge wildly.
Timing agnostic
Depreciation policy moves the needle
Accelerated depreciation lowers accounting profit early, suppressing ARR; straight-line keeps ARR smoother across the asset’s life.
Policy lever
Tax assumptions are pivotal
Pre-tax vs post-tax profit can swing ARR by double digits. Always match the tax convention your organisation or course expects.
After-tax reality
Salvage can flip comparisons
A modest annual profit with a chunky salvage value can beat a steady no-salvage project on average-base ARR, even if yearly profits are lower.
Terminal boost