IRR Calculator

Internal Rate of Return (IRR) Calculator

IRR – what is it?

This is another really important rate to help you understand your wealth. The IRR is an interest rate that illustrates how much money you will make from an investment, and which enables you to estimate its potential for growth over time.

It is useful rate for businesses in particular, as they need to know whether significant investment at any one time will accrue more money in the longer term than the initial investment costs. For example, if you are a car showroom expanding premises and borrow $50,000 to do so, you need to determine whether that significant investment will generate more money than it costs. If the loan you use to fund the expansion costs you 15% and the IRR looks to be 25%, it is a worthwhile investment. If the IRR comes in at 8%, however, it is not a good use of money to expand in that way.

The way IRR works is to differentiate between money at different points in time in line with the idea that receiving money now is more useful than receiving it in the future. So, all other factors being equal, the IRR would be higher for a business model where the expansion coincides with the point of year where sales are highest – when new reg plates come out – than for points of the year where sales are predictably slower.

If you are a business you want to plan your investments in such a way that your IRR is as high as it can be.

IRR is important – but not simple!

Calculating IRR is not always easy. So how do we do it?

The truth is we will have to play around with calculations to see how the IRR falls under different scenarios. To get your head round it you need to understand some other concepts, one of which is the idea of Net Present Value. This is because IRR calculations work when the NPV is zero.

So what is Net Present Value?

This is actually quite simple. The NPV is a measure of cashflow.

Look at these components.

Obviously, you need NPV to be a positive number, or else you are losing money. If the NPV is negative, your business will need to reexamine how it works. Positive NPVs therefore mean money is being made. Negative NPVs mean it is being lost.

To calculate the NPV of a project or part of your business’s operation, add the present values of all money coming in, and then subtract from that figure all the present values of money going out. Simply put, deduct your business expenses from your business income. (Be aware that ‘present value’ just means ‘right now’, and not, for example, what money or a business might be worth in a year’s time, after interest has been added, or after property values have risen etc. NPV is about now!)

IRR Example Calculation

You run a market stall for a weekend selling towels. You bought the stock for $250. The rental of the stall is $100. Your outgoings are therefore $350. You then have a busy weekend and sell everything – all 100 towels get sold for $6 each. Your income is therefore $600.

The NPV is therefore your income minus your expenses.

NPV = 600 – 350 = 250.

This means your stall business has a net present value of $250.

To get the IRR you now need to use the calculator. Enter the income and outgoings figures and you see that you have an IRR of 71.4%

Once you have calculated your IRR you can then focus on your profit margins with greater clarity.