Why calculate CAGR
There are some key things that you should note about the compound annual growth rate. First, it is not a representation of the actual rate of return or future value. It only serves as a method of forecasting the rate at which an investment may grow if it maintains the same growth rate over the entire forecast period. Moreover, the profits at the end of each accounting period within the set timeframe should be reinvested.
Nonetheless, calculating CAGR offers benefits such as:
1. Determining the value of an investment
Over time, the value of an investment will change. This is caused by fluctuations in the rate of growth or revenue growth. Either way, it's important to have a clear picture of what an investment's value is or what it's going to be at a later date.
In this regard, calculating the compound annual growth rate will help. It will give you insight into the investment's present value and allow you to make sound business decisions.
2. Comparing different investments
There are plenty of investment vehicles to choose from as an investor. The investment risk and interest rate varies with each. To choose the one that suits you, it's essential that you know what to expect from all available options.
By calculating the CAGR for each vehicle, you'll know the average return to expect during the investment period. With this information, it will be easier to compare different investments and determine the best one.
3. Analyzing historical returns
Understandably, your primary focus will be on potential earnings when making investment decisions. However, it's equally important to review the historical performance of an investment to determine whether projections are realistic.
When it comes to calculating the performance of investments over time, CAGR is the best formula. Moreover, it helps address the limitations of the arithmetic return. Therefore, you can use CAGR to analyze the historical returns of mutual funds, stocks, and savings accounts.
4. Tracking business performance and forecasting revenue growth
Aside from overall organizational growth, you can use CAGR to track the performance of specific business metrics. Once you know how these metrics perform, you have a basis for comparing them against each other.
In turn, this allows you to predict overall business performance and make revenue projections more accurately. Moreover, it puts you in a good position to achieve hypergrowth.
5. Discovering business strengths and weaknesses
Given the competitive nature of the business ecosystem, you cannot afford to have any organizational vulnerabilities. By comparing the CAGR of specific business activities with those of similar organizations, you can determine your company's weaknesses and strengths.