Under payback method, an investment project is accepted or rejected on the basis of payback period. Payback period means the period of time that a project requires to recover the money invested in it. Investors may use payback in conjunction with return on investment (ROI) to determine whether or not to invest or enter a trade. Corporations and business managers also use the payback period to evaluate the relative favorability of potential projects in conjunction with tools like IRR or NPV.

• Generally, a long payback period is determined by your own comfort level – as long as you are paying off one investment, you’ll be less able to invest in newer, promising opportunities.
• The payback period is the amount of time it takes to recover the cost of an investment.
• A higher payback period means it will take longer for a company to cover its initial investment.
• Between mutually exclusive projects having similar return, the decision should be to invest in the project having the shortest payback period.
• In this case, the payback period shall be the corresponding period when cumulative cash flows are equal to the initial cash outlay.
• It has a wide usage in the investment field to evaluate the viability of putting money in an opportunity after assessing the payback time horizon.
• As the equation above shows, the payback period calculation is a simple one.

Create a free account to unlock this Template

In essence, the payback period is used very similarly to a Breakeven Analysis, but instead of the number of units to cover fixed costs, it considers the amount of time required to return an investment. The decision rule using the payback period is to minimize the time taken for the return on investment. The Payback Period shows how long it takes for a business to recoup an investment. This type of analysis allows firms to compare alternative investment opportunities and decide on a project that returns its investment in the shortest time if that criteria is important to them. As you can see, using this payback period calculator you a percentage as an answer.

The Payback Period formula is a tool that can be incredibly useful for companies in projecting the financial risk of a project. In examining the results, you should be looking for the shortest possible payback period. In reality, projects are unlikely to have constant annual projected returns. In this case, setting up a table in Excel will help evaluate and estimate the payback period. Management will set an acceptable payback period for individual investments based on whether the management is risk averse or risk taking.

Personal Loans

• Are you looking to calculate the payback period for an investment project using Microsoft Excel?
• You can use the payback period in your own life when making large purchase decisions and consider their opportunity cost.
• For example, if it takes five years to recover the cost of an investment, the payback period is five years.
• The payback period is the time it takes an investment to generate enough cash flow to pay back the full amount of the investment.
• Investors may use payback in conjunction with return on investment (ROI) to determine whether or not to invest or enter a trade.
• Using the subtraction method, one starts by subtracting individual annual cash flows from the initial investment amount, and then does the division.
• Determining the payback period is useful for anyone and can be done by dividing the initial investment by the average cash flows.

•   The payback period is the estimated amount of time it will take to recoup an investment or to break even. The first column (Cash Flows) tracks the cash flows of each year – for instance, Year 0 reflects the $10mm outlay whereas the others account for the $4mm inflow of cash flows. There are some clear advantages and disadvantages of payback period calculations. You can use the Payback Period calculator below to quickly estimate the time needed to get a return on investment by entering the required numbers. As a student is deciding on a degree, they can research the average income from a career with that degree. Using that number, along with the projected cost of their student loans, they can project how long it will take before they have recovered their investment.

Payback method with uneven cash flow:

Using automated investing, you can choose from groups of pre-selected stocks. There are additional tools in the app to set personal financial goals and add all your banking and indeed vs ziprecruiter investment accounts so you can see all of your information in one place. If earnings will continue to increase, a longer payback period might be acceptable.

For instance, Jim’s buffer could break in 20 weeks and need repairs requiring even further investment costs. That’s why a shorter payback period is always preferred over a longer one. The more quickly the company can receive its initial cost in cash, the more acceptable and preferred the investment becomes.

How do I calculate the payback period?

The payback period is the time it takes an investment to generate enough cash flow to pay back the full amount of the investment. In this calculator, you can estimate the payback period by entering the initial investment amount, the net cash flow per period, and the number of periods before investment recovery. The Payback Period is the amount of time it will take an investment to generate enough cash flow to pay back the full amount of the investment.

Using the Payback Method

Since some business projects don’t last an entire year and others are ongoing, you can supplement this equation for any income period. For example, you could use monthly, semi annual, or even two-year cash inflow periods. The cash inflows fiscal year and fiscal period should be consistent with the length of the investment. Obviously, the longer it takes an investment to recoup its original cost, the more risky the investment.

Find out how GoCardless can help you with ad hoc or recurring payments. For the variable U, you would need to calculate the total amount of all periods where the total cash flow goes toward paying back the investment. Then you would subtract that amount from the total investment amount to find the unrecovered portion of the investment. Below is a break down of subject weightings in the FMVA® financial analyst program. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy. With active investing, you can hand select each individual stock or ETF you wish to add to your portfolio.

Everything You Need To Master Financial Modeling

Whether you’re new to investing or already have a portfolio started, there are many tools available to help you be successful. One great online investing tool is SoFi Invest® online brokerage platform. The investing platform lets you research and track your favorite stocks and ETFs.

Step-by-Step Guide to Calculate Payback Period

After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. On the other hand, Jim could purchase the sand blaster and save $100 a week from what are noncash expenses meaning and types without having to outsource his sand blasting. She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies. We explain its formula, how to calculate, example, advantages, disadvantages & differences with ROI.

How to Calculate the Payback Period With Excel

The answer is found by dividing $200,000 by $100,000, which is two years. The second project will take less time to pay back, and the company’s earnings potential is greater. Based solely on the payback period method, the second project is a better investment if the company wants to prioritize recapturing its capital investment as quickly as possible. For example, if solar panels cost $5,000 to install and the savings are $100 each month, it would take 4.2 years to reach the payback period.