When I calculate “internal rate of return (IRR)”, should I include cash balance?
Both are correct depending on what you are really trying to evaluate. If you only want to understand how that particular investment you were taking money in and out of did by itself than you would ignore the cash.  You might use this if you were thinking of replacing that particular investment with another but keeping the in/out strategy. If you want to understand how the whole investment strategy worked (both the in/out motion and the choice of investment) than you would definitely want to include the cash component as that is necessary for the strategy and would be your final return if you implemented that strategy. As a side note, neither IRR or CAGR are not great ways to judge investment strategies as they have some odd timing issues and they don't take into account risk.
Line one shows your 1M, a return with a given rate, and year end withdrawal starting at 25,000.  So Line 2 starts with that balance, applies the rate again, and shows the higher withdrawal, by 3%/yr.  In Column one, I show the cumulative effect of the 3% inflation, and the last number in this column is the final balance (903K) but divided by the cumulative inflation.  To summarize - if you simply get the return of inflation, and start by spending just that amount, you'll find that after 20 years, you have half your real value.  The 1.029 is a trial and error method, as I don't know how a finance calculator would handle such a payment flow. I can load the sheet somewhere if you'd like.  Note: This is not exactly what the OP was looking for. If the concept is useful, I'll let it stand. If not, downvotes are welcome and I'll delete. Problem with deciding investments in a company is that you have multiple potential options, each with their projected returns, but each also has some hard-to-estimate risks. A further problem is that these opportunities arrive one-by-one, so you usually cannot compare project A vs. project B to decide which one is better. The internal rate of return is a rule-of-thumb like way to make these decisions. The company board may set an IRR target of e.g. 15%, and each executive will compare their projects against that target. They'll execute only the projects that are projected to give a good return, but some of these projects will end up failing. Thus the real average profit will not be equal to IRR. Important thing is that this target number gives ways to compare projects, and also for the board to control the investments. If the company has a good track record of being successful at projects, the board might set an IRR target of 10% and expect to get e.g. 8% return on their investment. However, if the company has a much larger risk of projects failing, they might demand a predicted IRR of 20% to account for the risk. Ultimately if the IRR target is set too high, the company will find no projects it considers profitable to invest in. In practice if this happens, the company owners are better off taking out the cash as dividends and investing it elsewhere. The short answer is that you would want to use the net inflow or net outflow, aka profit or loss.   In my experience, you've got a couple different uses for IRR and that may be driving the confusion.  Pretty much the same formula, but just coming at it from different angles.   Thinking about a stock or mutual fund investment, you could project a scenario with an up-front investment (net outflow) in the first period and then positive returns (dividends, then final sale proceeds, each a net inflow) in subsequent periods.  This is a model that more closely follows some of the logic you laid out. Thinking about a business project or investment, you tend to see more complicated and less smooth cashflows.  For example, you may have a large up-front capital expenditure in the first period, then have net profit (revenue less ongoing maintenance expense), then another large capital outlay, and so on.   In both cases you would want to base your analysis on the net inflow or net outflow in each period.  It just depends on the complexity of the cashflows trend as to whether you see a straightforward example (initial payment, then ongoing net inflows), or a less straightforward example with both inflows and outflows.   One other thing to note - you would only want to include those costs that are applicable to the project.  So you would not want to include the cost of overhead that would exist even if you did not undertake the project. Your example isn't consistent: Q1 end market value (EMV) is $15,750, then you take out $2,000 and say your Q2 BMV is $11,750?  For the following demo calculations I'll assume you mean your Q2 BMV is $13,750, with quarterly returns as stated: 10%, 5%, 10%.  The Q2 EMV is therefore $15,125. True time-weighted return :- http://en.wikipedia.org/wiki/True_time-weighted_rate_of_return  The following methods have the advantage of not requiring interim valuations. Money-weighted return :- http://en.wikipedia.org/wiki/Rate_of_return#Internal_rate_of_return  Logarithmic return :- http://en.wikipedia.org/wiki/Rate_of_return#Logarithmic_or_continuously_compounded_return  Modified Dietz return :- http://en.wikipedia.org/wiki/Modified_Dietz_method  Backcalculating the final value (v3) using the calculated returns show the advantage of the money-weighted return over the true time-weighted return. Yes, if your IRR is 5% per annum after three years then the total return (I prefer total rather than your use of actual) over those three years is 15.76%. Note that if you have other cashflows in and out, it gets a bit more complicated (e.g. using the XIRR function in Excel), but the idea is to find an effective annual percentage return that you're getting for your money. You're 100% right! The IRR is the rate at which the project breaks even. You project cash flow/profitability metrics, and then you see what, under your projections, is the discount rate at which your project breaks even (the IRR).   But remember, it breaks even today! So it's saying that you should make a worthwhile investment today because the return that you will obtain at points in the future are worth you putting your investment in today! You still make a healthy return overtime if you project a reasonable IRR, but your IRR is showing you whether it's at least as worth it today to put your money in today (whether, given what you'll make over the future, it's at least as worth it to put your money in today). WRONG. Assuming each account has the same investment option the rate of return is not dependent on the initial amount of money in the account, but rather the allocation amongst said investment. Suppose based on your investment allocation in either account you gain 10% interest over the year.  In the first scenario your ending balance will be (30000+4800)*1.10 = $38,280.  In the second scenario your first account will be worth 30000*1.10 = $33,000, and the second account will be worth 4800*1.10 = 5280, for a total of 33000+5280 = $38,280. "(I'm assuming USA tax code as this is untagged) As the comments above suggest there is no ""right"" answer or easy formula.  The main issue is that you likely got into business to make money and if you make money consistently you will pay taxes.  Reinvesting generally should be a business decision where the main concern is revenue growth and taxes are an important but secondary concern. Taxes can be complicated, but for a small LLC shouldn't be that bad.  I highly recommend that you take some time closely analyze your business and personal taxes for the previous year.  Once you understand the problem better, you can optimize around it.  If it is a big concern, some companies buy software so they can estimate their taxes periodically through the year and make better decisions." "If you are considering this to be an entry for your business this is how you would handle it.... You said you were making a balance sheet for monthly expenses. So on the Balance Sheet, you would be debiting cash. For the Income Statement side you would be crediting Owner's Equity to balance the equation: Assets = Liabilities + Owner's Equity So if you deposited $100 to your account the equation would be affected thus: $ 100 in Assets (Debit to Cash Account) = 0 Liabilities - $100 (Credit to Owner's Equity) It is correctly stated above from the bank's perspective that they would be ""Crediting"" you account with $100, and any outflow from the bank account would be debiting your account." &gt; Does it make sense to calculate the IRR based on the outstanding value of the project, or just use the cash flows paid out?  What is the outstanding value of the project based on? I'm guessing it is the PV of net cash flow?  The timing of each cash outflow (i.e. investment) is crucial to calculating a proper IRR because of time value of money. Putting in $x each year for 49 years will give you a different figure from putting in $49x in the first year and zero for the next 48 years because a larger figure is tied up for a longer time period. No, it would not show up on the income statement as it isn't income. It would show up in the cash flow statement as a result of financing activities. IRR is not subjective, this is a response to @Laythesmack, to his remark that IRR is subjective. Not that I feel a need to defend my position, but rather, I'm going to explain his.  My company offered stock at a 15% discount. We would have money withheld from pay, and twice per year buy at that discount. Coworkers said it was a 15% gain. I offered some math. I started by saying that 100/85 was 17.6%, and that was in fact, the gain. But, the funds were held by the company for an average of 3 months, not 6, so that gain occurred in 3 months and I did the math 1.176^4 and resulted in 91.5% annual return. This is IRR.  It's not that it's subjective, but it assumes the funds continue to be invested fully during the time. In our case the 91.5% was real in one sense, yet no one doubled their money in just over a year.  Was the 91% useless? Not quite. It simply meant to me that coworkers who didn't participate were overlooking the fact that if they borrowed money at a reasonable rate, they'd exceed that rate, especially for the fact that credit lines are charged day to day. Even if they borrowed that money on a credit card, they'd come out ahead.  IRR is a metric. It has no emotion, no personality, no goals. It's a number we can calculate. It's up to you to use it correctly. Ok - what's your starting point?  Are you starting with equity value and then working your way back to an enterprise value?  Then yes, you must subtract cash and add debt.  If you're doing a DCF, you don't have to make any changes to the values at the end if you're looking for an enterprise value.  If you're looking for an equity value, you would need to add cash and subtract debt.  If you're simply applying a enterprise value multiple (such as EV / EBITDA) you don't need to make any changes.  Just multiply the Company's EBITDA by the multiple in question.  Enterprise values are supposed to be capital structure independent because they are only valuing the company on metrics that occur before the impact of the Company's capital structure. This is in the balance sheet, but the info is not usually that detailed. It is safe to assume that at least some portion of the cash/cash equivalents will be in liquid bonds. You may find more specific details in the company SEC filings (annual reports etc). "A mutual fund's return or yield has nothing to do with what you receive from the mutual fund. The annual percentage return is simply the percentage increase (or decrease!) of the value of one share of the mutual fund from January 1 till December 31. The cash value of any distributions (dividend income, short-term capital gains,  long-term capital gains) might be reported separately or might be included in the annual return.  What you receive from the mutual fund is the distributions which you have the option of taking in cash (and spending on whatever you like, or investing elsewhere) or of re-investing into the fund without ever actually touching the money. Regardless of whether you take a distribution as cash or re-invest it in the mutual fund, that amount is taxable income in most jurisdictions. In the US, long-term capital gains are taxed at different (lower) rates than ordinary income, and I believe that long-term capital gains from mutual funds are not taxed at all in India. You are not taxed on the increase in the value of your investment caused by an increase in the share price over the year nor do you get deduct the ""loss"" if the share price declined over the year. It is only when you sell the mutual fund shares (back to the mutual fund company) that you have to pay taxes on the capital gains (if you sold for a higher price) or deduct the capital loss (if you sold for a lower price) than the purchase price of the shares. Be aware that different shares in the sale might have different purchase prices because they were bought at different times, and thus have different gains and losses.  So, how do you calculate your personal return from the mutual fund investment? If you have a money management program or a spreadsheet program, it can calculate your return for you. If you have online access to your mutual fund account on its website, it will most likely have a tool called something like ""Personal rate of return"" and this will provide you with the same calculations without your having to type in all the data by hand. Finally, If you want to do it personally by hand, I am sure that someone will soon post an answer writing out the gory details."