CAGR is an imaginary number that describes the rate at which an investment or expenditure, such as outside counsel payments, would have grown if it grew during a period of time at a steady rate. Thus, if a legal department paid of $10 million to outside counsel in 2005 and five years later paid $20 million, then its spending grew 100 percent. True, but what was the smoothed-out rate of increase each year?
Here’s the answer, courtesy of the general formula for calculating CAGR:
CAGR = (ending amount / beginning amount) (1 / # of years) – 1
Thus (20/10) times raised to the power of 1/5 (.2) and subtract from 1 leaves the CAGR. In Excel the cell that calculates this contains =((20000000/10000000)^.2)-1, where the caret (^) is the POWER function. The compound annual growth rate was 14.9 percent. In other words, if the department had paid a steady 14.9 percent more each year during the five years, the $10 million would have swollen to $20 million.
General counsel who comfortably understand and use CAGR to describe their spending not only have a more nuanced understanding of run rates but also speak the language of their fellow business executives.