How to calculate the payback period

To assess the effectiveness of the investment project in financial management, various methods and criteria are used. The easiest way to evaluate the attractiveness of a project is to calculate the payback period.

Calculation of a simple payback period

The simple payback method is one of the easiest ways to evaluate a project. To calculate this indicator, it is enough to know the net cash flow for the project. Based on this indicator, the accumulated cash flow balance is calculated. When choosing between several investment projects for implementation, the project is accepted for which the payback period will be the shortest.

Suppose that the initial investment in the project amounted to 180 million rubles. The project will be implemented within 5 years, it will generate cash flows annually:

1 year: 40 million rubles

2 year: 30 million rubles

3 year: 50 million rubles

4 year: 70 million rubles

5 year: 90 million rubles

You need to calculate a simple payback period.

Using the data presented, it is necessary to compile an analytical table. The payback period for the project is calculated by summing the annual cash flows until the amount of cash inflows is equal to the value of the initial investment costs.

The table shows that the accumulated cash flow balance is positive between 3 and 4 years of the investment project. The following formula will help you calculate the exact payback period:

In this example, the payback period is: 3 years 10 months

The main disadvantage of this method is that the calculation does not use the discount procedure, and therefore, does not take into account the decrease in the value of money over time.