It is often necessary in financial reporting to extrapolate yearly results from results derived in a shorter amount of time. For instance, if a product has been on the market for three months, it may be useful to determine from these initial results the likely profits to be derived from the product over the course of the first year. In order to achieve this, it’s necessary to annualize the existing results. Thus, the accepted annualize definition is the extrapolation of available results in order to derive a twelve-month projected total amount.
The method for calculating annualization is fairly straightforward. First, it’s necessary to determine the length of time for which results are available. Then divide one year by that time period; for instance, one week of results can be annualized in the following way:
• ((52 weeks/1 week) * (results)) = annualized results
• 52 * results = annualized results
The same basic theory can be applied to any time period; one day would be annualized by dividing 365 days (a typical year) by one day, deriving results by multiplying the daily results by 365. Five days would be annualized by multiplying 73 (365/5) by the five-day results. By converting one year into the appropriate number of time measures (52 weeks, 365 days, 12 months) any time period can easily be annualized using this method.
Annualized percentage data
By using the same methods as with raw financial data, percentage changes can be annualized and compared readily to derive trends. This is useful for comparing growth rates from different years or time periods of different lengths within the same year. Real estate sales trends and unemployment data are two economic datasets that are often annualized in order to make fair comparisons between different time periods.
Annualized rate of return
Some systems derive the annualized rate of return on an investment by using a time-weighted method to annualize these figures. These methodologies tend to produce more accurate figures, since they take into consideration the length of time being measured, the number of measures taken during the time period, and a cumulative rate of return on the investment. These systems lack the simplicity and the clearly defined results that the standard annualizing method offers to financial advisors, however.
Financial analysts often annualize current figures in determining the economic forecast and predicting a company’s financial health. When based on nearly a year’s worth of data, these forecasts can be highly accurate; in general, the longer the period measured and known, the more accurate annualizing the results will be in forecasting returns over the course of a year. For market securities, annualization gives a ballpark figure for probable earnings; due to the volatility of the stock market, this figure is unlikely to be accurate without a sizable sample of existing results. Lastly, companies making estimated tax payments are often required to annualize their current profits in order to ensure proper payments to the Internal Revenue Service.