How is Internal Rate of Return (IRR) calculated?
IRR, or Internal Rate of Return, is a fundamental metric used to measure the annualised rate of return that your cash has earned over the life of an investment.
The IRR is a powerful indicator that reflects the rate at which the net present value (NPV) of future cash flows equals zero. In simpler terms, it's the discount rate that balances the sum of the present values of future cash flows with the initial investment.
Calculating IRR involves considering all cash flows and their timing. Here's a practical example:
- Initial cash investment of £1,000,000 on 01/01/2023.
- A withdrawal of £50,000 processed on 01/06/2023.
- When calculating the IRR as of 01/12/2023, we include the current value of the investment, which is £1,200,000.
If you have an LP (Limited Partner) account, your IRR calculation takes into account your ownership in the GP-LP fund:
All capital drawdowns are included as cash outflows.
All withdrawals to your LP account are considered as cash inflows.
The current value of the investment reflects your ownership percentage of the GP-LP fund's assets.