What is IRR – Building a Financial Model with IRR

As you already know, IRR or internal rate of return is one of the most used metric which investors look up to determine whether they should invest on a business or a project. Basically, it is the interest rate at which the net present value of all the cash flows from a project equal to zero. It enables the present value of the expected cash inflows equal to the present value of the estimated cash outflows of the project. Meaning, if the IRR is greater than the required rate of return then the project is likely profitable. On the other hand, if the IRR is less than the required rate of return, then it is best to not accept the project.

The IRR is one of the key ratios which helps measuring the profitability of a project. It is also used to maximize the net present value as an indication of profitability, efficiency, quality, or yield of an investment. Another way of using the IRR ratio is to calculate the fixed income and measuring new debt in terms of yield to maturity as well as for evaluating share issues and stock buyback programs for corporations. Others also use it for Private equity from a limited partner’s perspective so that they can measure the general partner’s performance as an investment manager, but basically, the IRR is mostly used for analyzing projects or investments, determining the returns, and to better understand the risks of the project or investment.

To calculate the internal rate of return, there isn’t a definite way to do so. However, there are two ways on how to calculate the IRR. First way is to make use of Excel’s built-in function which is the IRR function. It is one of Excel’s financial function that helps calculate the IRR. This function will result with a series of cash flows that occur at regular intervals. The second way to calculate the IRR is to break out all the component cash flows as you calculate each step individually which results will then be used as inputs for the IRR Formula. In the end, to calculate the IRR, the expected cash flows of a project or investment must be provided and that the net present value must equal to zero.

To learn more in detail on how to calculate the IRR and also get example financial model templates with IRR as reference, you can read more here: What is IRR and How to Calculate IRR. If you are looking for industry-specific or use case specific financial model templates, you can also get them at eFinancialModels, a platform which offers a wide range of financial model templates made by financial modeling experts as well as providing custom modeling services and assistance if you need help with completing your financial modeling tasks.