The term annualize means to convert a rate of anything that is measured for a period other than one year into a rate that reflects that rate on an annual or yearly basis.

Although this can be done for rates measured with periods of over one year, annualizing is usually done for rates that have periods of less than one year. Annualizing helps companies project results for a hypothetical full year, and filter out seasonality and abnormalities.

Examples of uses of annualization include projecting yearly income, return on investment (ROI) and production level.
Note that annualizing ROI will not factor in compounding interest, which means that the actual ROI might be higher that the ROI computed from the annualized interest.

For example, if for the first 3 months of the year you get a 2% interest each month in your investment, you can just assume that the remaining months will give you the same interest rate. That means that you can multiply 2% by 12, giving you an annualized interest rate of 24%.

If the interest is compounded, the actual ROI will be much higher than 24% of your initial capital. On the other hand, if the actual interest rates for the next months dip to 1% or lower, then the actual ROI can be lower than the projected 24% ROI. This means that seasonal changes weren’t properly accounted for in the second case.

Leave a response

Leave a Response