As a new business owner looking to measure growth, you’ll quickly find that there is no “black and white” way to do so. Companies choose different methods to measure growth. If you consider growth as more than the dollar amount of total revenues on the balance sheet, you’ll soon realize that measuring growth is more challenging than you’d think.
Two of the most popular ways to measure growth are the average annual growth rate and the compound annual growth rate. In this article, we’ll compare the two and explain how to find growth rate.
We’ll also go over market share and why it’s incredibly relevant when calculating the growth rate. After reading this article, you’ll have a clear understanding of how growth rate formulas can help you evaluate growth over a particular period of time.
What are growth rates?
The label “growth rate” is broad in that it refers to the change of a specific variable over a predefined time period. Owners typically express growth as a percentage. Growth rates can provide you with a more accurate depiction of financial health, especially when comparing percentage growth to industry rates.
Narrowing growth rate down to a percentage will level the playing field so that you can measure yourself against others in the industry. For instance, imagine you’re a small business selling a new tech product. If you were to compare your revenue to established tech firms, you’d probably find yourself lagging considerably.
But, if you notice that your yearly growth rate percentage is significantly higher than the growth rates of other firms, you can conclude that you’re more efficient with resources and have a more successful product.
The standard growth rate formula is straightforward. If you’re looking to use it to measure future value, the equation expressed in percentage form is:
Projected growth rate = ((Targeted future value – Present value) / (Present value)) * 100
So, let’s say that you are currently producing $50,000 in sales but want to reach $125,000. Your growth rate formula would be:
Growth Rate (Future) = ($125,000 – $50,000) / ($50,000) * 100 = 150%
This formula merely shows that you need to grow by 150% to meet your goal. You can also add time periods to the equation. All you need to do is divide your calculated growth rate by the number of periods you’d like to measure. This is called the annual rate.
For example, imagine that you want to grow to $125,000 in sales within three years. You’d like to figure out the monthly growth factor. Divide 150% by 36 to yield a monthly growth rate of 4.17%. You’ll need to exhibit a positive percentage change of 4.17 per month if you wish to hit your sales goal on time.
You can also calculate the growth rate as a measure of past performance. In these situations, the equation is:
Growth rate (past) = ((Present value – Past value) / (Past value)) * 100
If you add the number of periods into the equation, this allows you to determine the percentage increase or decrease that you displayed over any number of years.
Now that we’ve covered growth rates at the most basic levels, let’s look at in-depth ways to comprehend them. There are two different ways to understand growth rate — average annual growth rate and compound annual growth rate.
Average annual growth rate
The average annual growth rate (AAGR) is the average increase of a variable during the course of a calendar year. It’s an excellent tool to help measure average growth over a year. Variables that you can use when measuring AAGR include:
- Cash streams
The formula to calculate AAGR is:
AAGR = ((Growth rate period A) + (Growth rate period B) + (Growth rate period N)) / (Number of payments)
The average growth rate is particularly useful when predicting ending values and long-term trends. It allows small business owners and potential investors to evaluate the average percentage change that occurred over time. This allows them to predict ending values based on past performance.
Compound annual growth rate
The compound annual growth rate (CAGR) provides the rate of return necessary to grow investments, assuming that all profits and dividends are reinvested. Compound growth measures how long it takes to grow from its beginning value to its final value. The CAGR formula is:
Compound annual growth rate = ((Ending balance/Beginning balance) ^ (1 / Number of years)) – 1
If you have something that can rise or fall in value over time, then you’ll want to measure percentage changes using CAGR. The tool can help compare rates of returns from one investment versus another — say, a high-yield savings account versus a stock.
CAGR measures things in a perfect world, meaning the investment grows at the same rate every year, and you reinvest the profits each year. Although this may not always be the case with an asset like stocks, you can still use CAGR to understand and predict returns more quickly.
What is market growth rate?
Another way to interpret growth rates is by measuring market growth rates. However, to do this, you must first understand market share. Market share indicates how many of your sales (or other variables) make up the market totals. The market share formula is:
Market share = (Your firm’s sales / Total industry sales) * 100
For instance, let’s say that the total sales in your sector were $5 million last year. Your firm had $100,000 in sales. $100,000 / $5 million is .02. If you multiply this by 100, you find that your market share is 2%.
You can also substitute other variables into this equation as well. It’s easy to measure a company’s market share by comparing things such as revenues, cash on hand, or available assets. Market share is useful for determining the business’ size in comparison with others in that specific market.
How to find the growth rate in relation to the market
Market growth rate allows you to measure percentage growth over a specified time frame for your industry. To do so, you’ll need to know the total market size in terms of revenue. This includes total sales of the entire market with you and all competitors combined. The resultant sum is your current market size.
Next, determine your starting value. For example, let’s say you want to see how you grew relative to the industry over the past five years. Calculate total market revenues from five years ago, which will yield your original market size.
When you subtract the original market size from the current market size, you’ll have a change in the market. Divide the change in market size by the original market size, and multiply by 100 to obtain your market growth rate. The formula is:
Market growth rate = ((Current market size – Original market size) / (Original market size)) * 100
Remember that earlier, we gave you the formula to calculate growth rates for any equation. By comparing the market’s growth rate with a product’s total sales growth rate, businesses can evaluate the success or failure of a given product or service. If your sales are growing by 10%, but the total market sales market is growing by 20%, you are lagging behind your competition.
While the math for finding your market growth rate seems simple, the process of collecting the necessary data to evaluate yours and your competitors’ growth rates is far more complex. Tools like Sizeup let businesses analyze how they compare to similar companies in their areas. Using reliable accounting software can also make it easier for you to calculate growth rates, instead of having to do so manually in Excel.
Additionally, business owners should do their research to predict future developments in their market areas. By assessing growth drivers and evaluating the performance of similar products or services in the marketplace, you can forecast your growth for the coming months and years. Companies can also review economic industry data to evaluate emerging trends and market forces.
It’s important to note that market and company growth rates vary by industry. For example, a reasonable growth rate for a clothing company might be considered low or even failing compared to a company in the technology industry. By analyzing the market and your competitors, you can better determine what growth rate is healthy for your business.
Why market growth rate is important
Assessing the market growth rate is essential to crafting goals and visions for your company. Companies experiencing low sales growth relative to their competitors should investigate the potential causes of their performance issues, such as high prices or insufficient advertising, and take steps to correct them moving forward.
Additionally, the market growth can indicate your business’s long-term sustainability. While a high growth rate means low saturation and high demand, a negative rate could suggest that consumers are losing interest in your product or service.
Market growth rates are also relevant to financial institutions, which may use this information to decide whether to invest in your company. Investors will assess trailing growth rates to determine how successful the company has been in recent years.
Using this information, they can predict forward-looking rates for future months and years. If prospective rates for a business and its market are favorable, investors are more likely to acquire and retain company shares.
Use growth rates to push your business to the next level
The market growth rate is an essential factor when evaluating the viability of a new or existing business venture. By assessing your current rate of growth and comparing it to your industry or your competitors, you can make informed decisions regarding business planning strategies moving forward.