When you annualize a number, you calculate what that number would look like if the whole year of results were available. You might annualize your income, a rate of return or turnover of employees, for example. To annualize, you need to know the number and what time period that number represents. Once you understand the basic concept of how to annualize a number, you can apply it in many situations.
How to Annualize Income
You might need to know annualized income when applying for unemployment benefits, filling out a credit application, negotiating pay at a job interview or determining the amount of estimated tax to remit to the IRS. For self-employed individuals, including partners of an LLC, the estimated tax payment might be the most serious of these considerations. Generally, you are safe from penalty if you pay at least 100 percent of the tax you owed in the prior year. So if, in 2017, you owed $20,000 at tax time, you will need to make your quarterly estimated tax payments in the amount of $5,000 each throughout the 2018 tax year. If your business experiences seasonal fluctuations, you might not have made much profit by the time an estimated tax payment is due. By using annualized income, you can pay less in the quarters where you haven't earned as much. The IRS provides Worksheet 2-7 in Publication 505 to help with this calculation. You will need to know your net profit for the period in question and amounts for your typical deductions.
To annualize income, you can multiply the income by the number of times per year that you receive it. If you receive a monthly salary of $5,000, your annual income is: 5,000 * 12 = $60,000.
How to Annualize Returns
With so many different types of investments available, investors need a way to compare performance. It could be difficult to compare a short-term investment's performance to a long-term one because of time. You need a way to account for the length of time it took to achieve that return. That is the purpose of the annualized return formula, which gives us the annual percentage yield, or APY. The formula is APY = (( 1 + rate of return)^4) - 1.
You receive your investment statement for the first quarter. It says that your fund had a rate of return of 6 percent for the quarter. You have another investment that you have held for one month, and in that month you had a 3- percent rate of return. You are about to receive a $2,000 windfall and you want to decide which is the best option for your money.
The 6 percent investment's APY is calculated as follows:
APY = ((1 + .06)^4) - 1 = 26.25 percent
The 3 percent investment's APY is:
APY = ((1 + .03)^12) -1 = 42.58 percent
Even though the percentage was smaller on the investment you only held for a month, it will make a larger return over time.
How Do You Calculate Annualized Turnover?
Human resources professionals look at turnover rates, the rates at which employees leave the company, as an important metric. If turnover is high, something may be wrong with how the company is recruiting, training or engaging with the workforce. To find this rate, the HR professional would look at the average number of employees each month and the number of employees who separated from the company in that period to find the turnover rate. The rate can then be annualized and compared to other companies in the same industry to determine if there is a problem.
For example, Annie's Apples has 100 employees, on average, each month for January, February and March. Since January 1, 12 employees have quit. Turnover is 12 divided by 100, or 12 percent. Since the data was for three months – or one fourth – of the year, multiply that 12 percent by 4 to find the annual turnover rate of 48 percent.
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