IRR, or Internal Rate of Return, measures the average annual return of an investment over its full life, including both ongoing cash flow and sales proceeds. Unlike ROI, which is calculated one year at a time, IRR evaluates the entire period. To calculate IRR, you account for the initial investment, annual cash flows, and the sale proceeds in the final year. For example, an initial investment of $898,750 with ten years of cash flow plus sales proceeds of $3,847,926 resulted in an IRR of 24.6%. IRR is especially useful for comparing deals or when raising investor capital, because it shows the total return potential across time. In some cases, a five-year IRR may be higher than a ten-year IRR depending on exit timing.
