What Is a Payback Period?

The payback period is also referred to as "the payback period of the investment". The time (years) required for the total income obtained after the investment project is put into operation to reach the total investment invested by the investment project. There are several ways to calculate the payback period. Depending on the starting point of the investment recovery, there are two types of calculations: from the date the project is put into production and from the day the investment is used. According to the main body of the investment recovery, there are social investment recovery periods and enterprise investment recovery periods. The income structure is different, and there are a payback period for profit and a payback period for return on investment. ^[1]

Payback period

Payback period is the time required to make the accumulated economic benefits equal to the initial investment costs.

The payback period is the number of years that the investment can be recovered through the return flow of funds. The standard payback period is the average advanced payback period prescribed by the state according to the technical and economic characteristics of the industry or sector. The additional investment recovery period refers to the use of additional capital backflow including additional profits and taxes and additional fixed asset depreciation.

The payback period can be divided into

The payback period indicators are easy to understand and the calculation is relatively simple; the payback period of a project shows the turnover rate of capital to a certain extent. Obviously,

(Payback Period) The investment payback period refers to the period required for the accumulated cash flow from the investment to equal the original investment amount, that is, the period required to recover the original investment.

Formula for calculating payback period

If the annual net cash flows of the investment project are equal, then:

Payback period = original investment amount / annual net cash flow

If the annual cash flow of an investment project is not equal, and the investment payback period is greater than or equal to n and less than n + 1, then:

Investment payback period = n + to the n-th amount that has not been recovered / net cash flow in the (n + 1) period

Investment decision rules for the payback period method

The company first determines a standard or minimum life, and then compares the payback period of the project with the standard life. If the payback period is less than the standard period, the project is feasible; if it is greater than the standard period, it is not feasible.

Advantages and disadvantages of the payback period method

The advantage of the payback period method is that the calculation is simple, easy to understand, and to some extent takes into account the risk status of the investment (the longer the payback period, the higher the investment risk, and conversely, the lower the investment risk).

However, there are some fatal shortcomings in the payback period: first, it does not consider the time value of the funds, and assigns the same weight to the cash flow of each period; second, it only considers the contribution of the cash flow before the payback period to the investment income The cash flow after the payback period is not considered; the third is that the standard period of the investment payback period is determined to be subjective.