Compound Annual Growth Rate (“CAGR”)
What It Means
Compound Annual Growth Rate, or CAGR, is an implied constant rate of return based on actual growth over a period of time (usually a number of years).
CAGR is calculated using the following formula:
Compound Annual Growth Rate (“CAGR”) - CALCULATOR
Why It’s Important
CAGR is often used by Buyers to project growth over time in a Pro Forma model because it smooths out the year to year fluctuations in growth to give a better figure for how well a company has performed over a longer period of time.
Example
If a company had the following revenues over a 5-year period, here’s how their annual growth rates would vary year to year:
Notice the wild fluctuations in growth between any given year? In contrast, here is the CAGR over the same period:
This means that if the company had started out at $600,000 and grown by 38.4% per year between year 1 and year 5, it would have ended up at the same final value of $2,200,000. Buyers would use this CAGR value as a reference when projecting potential future growth.