A payback period calculator helps you find out the time taken to recover the investment made in a project. A payback period is the time span taken for an investment to reach a break-even point. Businesses and individuals invest money in various projects or works as they want to be paid back. A shorter payback period is always preferred as compared to a longer payback period. And hence calculating payback period is both important and useful.
Did you know?
A shorter payback period is preferred over a longer payback period.
What is Payback Period?
The payback period is the time that it takes to recover the investment cost. It is also referred to as the time an investor will need to reach the breakeven point. The payback period helps to analyse the project's complexity and reliability. A shorter payback period means more attractive investments. Whereas the longer payback period means the investments are not that worthwhile.
This period can be calculated using a payback period calculator. By providing accurate information, the calculator calculates the payback period time.
How do You Calculate Payback Period?
The payback period formula is as follows:
PP = I ÷ C
where,
PP = Payback period in years
I = Total sum invested
C = Annual cash in-flow – the money earned
What is the Payback Period Calculator?
A payback period calculator is a utility tool. As the name suggests it calculates the payback period of an investment. It is made up of a formula box. We require the initial investment amount and the periodic cash flows to find out the payback period. The calculator calculates and shows the payback period of the investment.
Also Read: What is Accounting Cycle: Definition and Steps in the Accounting Cycle Process.
How to Calculate the Payback Period with Even Cash Flow?
The formula when the calculation of the payback period for an investment when net cash flow is even (equal) is:
Payback period = Initial Investment / Net Cash Flow per period
How to Calculate the Payback Period for Irregular Cash Flows?
The payback period formula uneven cash flows is mentioned below:
Payback period = Years before full recovery + Unrecovered cost at the start of the year / Cash flow during the year
Calculating Payback Period Using a Payback Period Calculator
The payback period calculator helps to find out the time used to recover the initial investment. To calculate, the following mathematical formula can be used.
Payback period = Initial investment / Cash flow per year.
We will now discuss this with an example in order to better understand it.
Say you have invested ₹ 2,00,000/- with an annual payback of ₹ 40, 000/-
Now, putting this value in the formula
PP = I ÷ C
where,
PP = payback period in years
I = Total sum invested
C = Annual cash in-flow – the money earned
PP = ₹ 2,00,000 / ₹ 40,000
PP = 5 years
Now let us calculate the payback period for irregular cash flows.
For example, your investment in the project is ₹ 4,00,000. The expected return in the first year is ₹1,40,000. In the second year, the expected return is ₹ 1,20,000. In the third year, it is ₹1,10,000. In the fourth year, the return is expected to be ₹80,000/-. The fifth-year will give ₹60,000/- return and ₹50,000/- in the sixth year.
The below-mentioned formula is to be used:
Payback period = Years before full recovery + Unrecovered cost at the start of the year / Cash flow during the year
Payback period = 3 + (400000 – 370000) / 80000 = 3.375
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Benefits of Payback Calculators
Below mentioned are the benefits of using payback calculators:
- A payback calculator is a simple tool that helps calculate returns on investments
- It is helpful in evaluating the benefits of an investment
- It helps rule out the risks involved in an investment
- It also guides in the reinvestment of earnings and making profits
Payback Period Formula for Uneven Cash Flows
You must follow the below-given steps to calculate the payback period during irregular cashflows:
Step 1 – Make a table and write down the cash flow for every year
Step 2 – Now, calculate the present value of each cash flow. The below-mentioned formula should be used
PVi= Ci / (1 R)^i
where,
- PVi = Present value of the cash flow of the year
- R = Discount rate
- Ci = Future value of cash flow of the year
- I = The year, which is equal to 0 when investing, then one for year 1
Step 3 – Now, find out the cumulative value for the cash flows. It can be calculated by adding the cash flow in the year with the total sum of cash flows of the preceding years. Here, the initial investment is an expense, so it is taken as a negative value.
Step 4 - Create a final table with the results.
Step 5 – In the final table, the break-even point is when the cumulative present value will change from a -ve to a +ve number.
Step 6 - To find out the exact duration, the discounted payback period formula given below should be used:
DPP = X + Y/Z
Where,
X = Year before which DPP occurs or the last year with a negative balance
Y = Cumulative cash flow in year Y (expressed as a positive value)
Z = Discounted cash flow in the year following year Y
Also Read: What are Accounting Principles and Accounting Concepts - Here's a Detailed Overview
Advantages and Disadvantages of the Payback Period Calculation
The advantages are mentioned below:
- It is a very simple process of calculation
- The calculation provides an overview of how soon the initial investment can be recovered
- It provides the facility to analyse two competing projects side by side by calculating the payback period. The project with a shorter payback period will be a better option as compared to the project with a longer payback span
The disadvantages are mentioned below:
- A major disadvantage of the payback period calculation is that it does not provide information about the specific profitability of a venture. It only shows the time span used to recover the investment
- In case the investors need to decide between two projects it becomes difficult to decide on the basis of the payback period alone as it can be to their disadvantage in the long run
- The payback period is not realistic as it is only a measurement
- The calculation of the payback period does not focus on the overall profit of the investment
Also Read: Profit and Loss Account & Statement
Conclusion:
We hope this article has been of help in providing details about the payback period calculators. Despite its limitations, the payback period calculation system is a very simple method for analysing a project. It takes care of the simple requirements like – the time required for the initial investment to reach a break-even point i.e. when the investment is recovered.
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