Every Monday we publish education on key business metrics you can use to operate and scale your company. This week we cover Compound Annual Growth Rate (CAGR).
COMPOUND ANNUAL GROWTH RATE (CAGR)
CAGR helps assess the historical growth of a business while also serving as a barometer for future potential performance. Compound Annual Growth Rate is most commonly used to assess multi-year growth in revenue and profit.
Compound Annual Growth Rate (CAGR) is considered a multi-period growth metric. Whereas a single period growth metric might serve as a target for a quarter or a year, CAGR measures growth over a relatively longer period of time (i.e. multiple years).
While a reasonable CAGR differ by industry and maturity of the underlying business, double-digit growth is typically attractive to investors and business owners alike. All things in moderation however, as a CAGR that is too high can indicate unsustainable growth. A company that expands too rapidly risks failure if the appropriate infrastructure (people, processes and systems) has not been put in place to sustain and support rapid growth.
Calculating Compound Annual Growth Rate:
-
- Step 1: Divide the Ending Value by the Beginning Value.
- Step 2: Raise the result to one divided by the power of the number of years covered)
- Step 3: Subtract One from the resulting number
Example
-
- 2017 Revenue: $150,000
- 2019 Revenue: $450,000
- Step1: ($450,000 / $150,000) = 3
- Covered Period(1): (2019 – 2017) = 2 years
- Step 2: [3 ^ (1/2)] = 1.73
- Step 3: 1.73 – 1 = .73 or 73 percent
In this example, the company’s revenue has a Compound Annual Growth Rate of 73% from 2017 through 2019.
(1) While three years are used for the calculation, the covered period is only two years. The starting point is revenue as of 12/31/2017, making the covered period 2018 and 2019.
THE BOTTOM LINE
It is difficult to improve what you do not measure. The first step in any business strategy is to determine the important metrics to achieve your goals and measure them. Regularly monitoring your Revenue and Profit CAGR will allow you track your company’s growth. In doing so, you can make sure the business is growing at a rate that is sustainable, reasonable for your industry and attractive to investors and potential buyers.
If you would like to learn more about other key metrics to help in your decision making or could use a partner to help build a custom KPI Dashboard for your organization, contact us for a free strategy call.