A simple guide

to ROI and IRR

→
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🟢ROI shows my return in DOLLARS

🟢IRR shows my ROI adjusted for TIME

You need both to understand the

return of an investment.

I’ll explain →

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🟢Let's start with the easier one: ROI.

ROI means "Return on Investment"

(↑ btw, this is often called MOIC or

"Cash-on-Cash")

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If I invest $100 and get back $200
my ROI is 2.0x = ($200 / $100)

If I invest $100 and get back $300

my ROI is 3.0x = ($300 / $100)

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But now let's introduce TIME...

If I make 2.0x in one month, great!

But if I make 2.0x in 100 years... not so

great.

So I need a way to measure my ROI over

TIME as well.
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 🟢 That's where IRR comes in.

IRR means "Internal Rate of Return,"

and while IRR is often used alongside

NPV & DCF analysis,

I want to simplify it further →

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Let's say IRR means the "annualized
rate of return for an investment."

In other words, "what percent did I

make PER YEAR?"

10%? 25%?
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Let's go back to the examples from earlier...

▪️ 2.0x in one month: 409,500.0% (← ...uh🤔?)

▪️ 2.0x in 100 years: 0.7% (← makes more

sense)

This is where IRR can be misleading and why

it's common for private equity folks to say
"you can't spend IRR."
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IRR calculates an ANNUALIZED percent
return, so big returns in the early days
can skew the numbers.

If I crush it in the first month, my IRR

formula says, "whoa! you're gonna keep
this up all year — nice!"

But in reality it won't play out that way.

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The IRR starts to feel more "palatable" as time goes by, for example:

▪️ 2.0x after 6 months: 300%

▪️ 2.0x after 1 yr: 100%

(↑ I doubled up in one year, and IRR is an annualized number, so it's

100%)

▪️ 2.0x after 2 yrs: 73%

▪️ 2.0x after 3 yrs: 44%

▪️ 2.0x after 4 yrs: 32%

(↑ see how it drops off steeply & then smooths out?)

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 🟢 And this is why you need BOTH.

Without the other, they can both be

misleading.

So you compare them side-by-side:

“As of [date] my ROI was [X] and my IRR

was [Y].”
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Note, this gets trickier once you factor in timing
of cash flows...

If I invest $100, get $120 back in month 2 and

$80 back in month 6,

I've still made 2.0x, but my IRR will be much

higher than 300%.

(↑ conversation for another time, but in Excel,

you can use the XIRR function to navigate this).
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So how do I think about it in my head?

I just compare any private investment to the stock market.

If I can open a brokerage account, pay basically no fees,

take my money out anytime, and make 7-10% on
average...

Then locking up my capital in an illiquid private investment

(that has fees) must have a MUCH higher IRR than 7-10%.

That premium needs to compensate me for the additional

risk I'm taking.

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 Which leads me to a common private
equity metric...

Most deals target 3.0x over 5 years at a

~25% IRR.

This is the goal post set in most models.

(↑ much higher than the market to

compensate for the risk)
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Thanks, I’m Chris.

What I do:
• M&A / FP&A Consulting
• Financial Modeling Education

Whenever you’re ready, there are 3

ways I can help you (in the
comments) ↓
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