What is Calculating The Compound Annual Growth Rate(CAGR)?

Calculating the Compound Annual Growth Rate(CAGR) is the way to measure the average annual rate at which a business, investment, or financial metric grows over a specific period of time, assuming the growth compounds every year. CAGR, or compound annual growth rate, is a standard metric for measuring revenue CAGR, investment returns, and the long-term growth of a business. 

The CAGR formula is:

Where, 

• • Ending value is the value at the end of the period. 
  • Beginning value is the value at the start of the period. 

• Number of years is the length of the period being measured. 

CAGR Calculation Example

Say a startup’s annual revenue grew as follows over three years:

• Year 1: $500,000
• Year 2: $650,000
• Year 3: $912,000

Using the formula:

CAGR = ($912,000 ÷ $500,000)^(1/3) − 1 = ≈ 22.1%. Even though growth wasn’t identical each year, the startup’s revenue CAGR works out to roughly 22.1%, meaning if it had grown at a perfectly steady rate, that’s the annual pace it would need to hit the same ending value.

CAGR vs. Average Annual Growth Rate

These two terms are often mixed up, but are different from each other:

• CAGR takes compounding into consideration; each year’s growth rate is compounded off the previously grown figure.
• Average annual growth rate is an arithmetic mean of year-on-year percentage change figures, which might be biased by outlier years and does not consider compounding.

Therefore, CAGR is usually recognized as the better tool for depicting growth across multiple time periods.

Why is CAGR Important for Businesses?

• It clarifies the direction of growth: CAGR provides a clear figure for founders, investors, and analysts to understand the growth path of a company or its investments.
• Facilitates comparison of different investments or companies: Because it shows a standardized growth rate in annualized form, CAGR allows comparing the growth of different investments or businesses on the same grounds despite different growth patterns.
• Helps forecast future performance: CAGR provides useful information about the past growth of the business, helping to set growth targets for the future.
• It is an important fundraising benchmark: Investors, when evaluating the revenue CAGR of a startup, use it as an indicator of momentum and scalability of a company.

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