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Definition: Compound Annual Growth Rate (CAGR)
Compound Annual Growth Rate (CAGR) is the rate, or the ratio, which defines the growth of a investment/business for a given time period. CAGR is more of a mathematical concept which is used to calculate the effectiveness of a business investment. CAGR uses the compounding formula to know the rate of growth in coming few years. It assumes that the growth will be steady at a constant rate of return.
CAGR=(End Investment Value/Start Investment Value)1/(Number of Years) - 1
CAGR Application and Usage
CAGR assumes that the rate would be steady over the period of years specified which may be correct for theoretical/mathematical purposes but may not happen in the business world.
Business does not work on steady rate of growth as there are lot of factors. But cage can help get an estimation of the growth given circumstances are not too volatile in future. It helps in knowing the growth in short period of time where the environment or market may be much more in control.
Some applications of CAGR include calculations of growth in investments like deposits, bank accounts or for comparing business on a fixed rate of growth. Savings bank account can be a useful application for CAGR where the growth or interest rate is constant. CAGR is also used in forecasting.
If a business has Revenue of 10000$ at end of this year and it is assumed that after 5 years from now it becomes 60000$.
Then the calculation would be
CAGR=(60000/10000)1/(5) - 1=.4309
This means in percentage CAGR is 43.09%
Hence, this concludes the definition of Compound Annual Growth Rate (CAGR) along with its overview.
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