Understanding IRR (Internal Rate of Return) in Private Equity

The Internal Rate of Return (IRR) is a financial valuation method frequently used in [Private Equity](/en/blog/quest-ce-que-le-private-equity-pe). IRR measures the expected return on an investment. It is a financial indicator that compares returns with those of most other investments.

It is calculated to determine the annual rate of return on an investment project by using the expected cash flow for the project and comparing the cash flow to the initial present value of the investment. IRR is an indicator of the expected profitability of an investment.

IRR is in fact the rate of return that causes the investment's current net cash flow to balance out at zero. Thus, the IRR calculation calculates the annual rate of return the investment must produce to be accounting neutral.

The higher the IRR, the faster the payback and the more successful the investment. What's more, calculating IRR is a useful way of comparing different investment projects and deciding which one offers the best potential return.