Average Annual Growth Rate (AAGR)

What Is the Average Annual Growth Rate (AAGR)? The average annual growth rate (AAGR) shows the average value of the annual return on investment, asset, portfolio, or cash flow over time. AAGR is a linear financial metric that neglects compounding effects and is calculated by taking the simple numerical average of a series of year-on-year growth rates.  Understanding the Average Annual Growth Rate  The average annual growth rate is useful for determining long-term trends to give investors an idea of the company’s financial health and the direction the company is headed. It can be applied to any type of financial measure, such as expenses, cash flow, revenue, etc. The ratio comes at a cost as it does not calculate any measure for the potential risk i.e., the fluctuations that occur during the initial and final periods are not accounted for. How Is the Average Annual Growth Rate Calculated? The formula for the average annual growth rate is:  AAGR = (GR1 + GR2 +… + GRn) / N where:  GR1 = Growth rate in period 1 GR2 = Growth rate in period 2 GRn = Growth rate in period n     N     = Total number of periods The AAGR is usually presented as a percentage. AAGR Step-by-Step Example Given the following revenues for XYZ LLC. 2022 = $120,000    2023 = $150,000    2024 = $135,000    2025 = $120,000Year 1: 0 growth. Year 2: GR1 = {($150,000 / $120,000) – 1} x 100 =  25%   Year 3: GR2 = {($135,000 / $150,000) – 1} x 100 = -10% Year 4: GR3 = {($120,000 / $135,000) – 1} x 100 = -11% AAGR = (GR1 + GR2 +… + GRn) / N AAGR = (0% + 25% – 10% – 11%) / 4 AAGR = 1% The AAGR for the revenue of XYZ LLC. is 1%. Limitations of AAGR Consider the above example. The initial revenue in 2022 was $120,000 and the final revenue in 2025 is also $120,000, but the Average Annual Growth for the time period is +1%. It is evident that the revenue yields a 0% growth return, but the AAGR is 1%. After all, we started with $120,000 and ended at $120,000. This discrepancy is caused because AAG doesn’t account for compounding and is a rough estimate. It is useful for depicting trends, but it can be deceiving as it does not accurately depict fluctuating rates. Due to this inconsistency, companies prefer to use the compound annual growth rate (CAGR). The CAGR removes the effect of compounding and the volatility of periodic returns and calculates the growth rate dynamically.