Annualized Values

Often, something occurs over a short period, but needs to be compared to a full year. This is known as annualizing. An example: You are applying for auto insurance, and the agent asks you what your yearly mileage is. You know that you drove 1,000 miles in the last month. The annualized rate, therefore, is 12,000 miles.

In continuous improvement, you will likely be dealing with a great many metrics. You will have annual targets—perhaps for dollars of cost savings, number of people trained in kaizen, or productivity improvements.

Translating gains from small time windows into an annual number helps to understand the true impact of a project, and lets you know if you are on track to hit your yearly goals.

Let’s say project A saves $11,000 over a one-and-a-half-month period, and project B saves $17,000 over a 2-month period. Which is saving more money? Project A is on an annualized pace of about $88,000, while project B is on pace to save $102,000. Annualizing helps with comparisons.

When deciding to annualize numbers, there are a few things to consider. First, do you want to use a discount rate? This means that current gains are more valuable than future gains. Typically, this is not done within the same year, though it could be if desired.

Second, is the projection likely to be linear? If you have seasonal sales, you might want to project Q1 sales at the historical percentage, rather than as if sales would be flat.

Be careful of projecting out one-time events. A single project in January that yields a 3% reduction may not translate into a 36% annual improvement rate. If sales rose, however, by 1% in each month of the first quarter, it is much more believable that the rate will continue to rise.

The basic formula for annualizing is to take the whole time period, divided by the elapsed time period, and multiply it out by the current value.

In the example of project A above, the annual savings was calculated by taking 12 months (whole time period) divided by 1.5 months (observed time), yielding 8. Multiplying that number by the $11,000 (realized value) gave $88,000 (annualized value).

One final note: Make sure units are constant—don’t compare months and weeks.