PP investment payback period

The payback period of an investment is the time it takes for an investment to generate sufficient cash flows to recoup investment costs. Together with Net Present Value (NPV) and Internal Rate of Return (IRR), it is used as an investment appraisal tool.

ROI is an excellent metric, providing you with a simplified way of knowing how long it will take for a firm to recoup initial expenses. This is of particular importance for businesses located in countries with unstable financial systems, or businesses associated with advanced technology, where rapid obsolescence of goods is the norm, which makes the rapid recovery of investment costs an important issue.

The general formula for calculating the payback period of an investment is:

Current (PP) - payback period of investments;

n is the number of periods;

CFt - inflow Money in period t;

Io - the value of the initial investment in the zero period.

Defined: as the time it takes for an investment to generate sufficient cash flows to recoup investment costs.

Characterizes: financial risk.

Depending on the goal, it is possible to calculate the payback period of investments with different accuracy (example No. 1). In practice, a situation often occurs when in the first periods there is an outflow of funds and then the sum of cash outflows is put on the right side of the formula instead of Io.

Example #1. Calculation of the payback period of investments.

The size of the investment is $115,000.

Investment income in the first year: $32,000;

in the second year: $41,000;

in the third year: $43,750;

in the fourth year: $38250.

Let us determine the period after which the investment pays off.

The sum of income for 1 and 2 years: 32,000 + 41,000 = $73,000, which is less than the investment of $115,000.

The amount of income for 1, 2 and 3 years: 73,000 + 43,750 = 116,750 is more than 115,000, which means that the reimbursement of initial expenses will occur earlier than 3 years.

Assuming cash inflows are evenly distributed throughout the period (by default, cash is assumed to be received at the end of the period), then the remainder from the third year can be calculated.

Remainder = (1 - (116750 - 115000)/43750) = 0.96 years

Answer: the payback period is 3 years (more precisely 2.96 years).

Example #2. Calculation of the payback period of investments.

The amount of investment is $12800.

Investment income in the first year: $7360;

in the second year: $5185;

in the third year: $6270.

Calculate the payback period of the investment.

Determine the period after which the investment pays off.

The sum of income for 1 and 2 years: 7360 + 5185 = $12545, which is less than the investment of $12800.

The amount of income for 1, 2 and 3 years: 12545 + 6270 = 18815 is more than 12800, which means that the reimbursement of initial expenses will occur earlier than 3 years.

Assuming that the cash inflows are evenly distributed over the entire period, then you can calculate the remainder from the third year.

Remainder = (1 - (18815 - 12800)/6270) = 0.04 years.

Answer: the payback period is 3 years (more precisely 2.04 years).

You can easily calculate the payback period of your project using the formula: A = B / C, where A is the project's payback indicator; B is the amount invested in the project; C is the net annual profit from the project implementation. As we can see, with the help of simple mathematical calculations, you will receive a specific period that will be necessary to return the funds you invested in the project.

It is important to consider that this calculation formula only works if the following requirements are met, namely:

In all investment cases, investments must be made once;

All cases in which funds were invested must have the same period of economic existence;

After investing funds, every year the investor will receive the same amount of money during the entire period of the investment project.

An example of calculating the payback period of an investment project

An example of renting an apartment, room or house. Let's say you invested in real estate and bought a $100,000 house to rent out. You expect to receive $600 in rent each month. What is the payback period for such a project? It is very easy to calculate this by referring to our formula.

B = $100,000 / C = $600 / month ($7200 / year), hence A = 100000 / 7200 = 14 years. That is, after 14 years you will fully return the invested funds and begin to receive a net profit.

(PP is the rate of return on the investment project; Io is the size of the initial investment; P is the net annual cash flow from the implementation of the case).

Calculation of the payback period of investments according to the formula.

For a more complete understanding of how to calculate the payback period, consider an example. Let's say the company made one-time investments, the amount of which amounted to 50 million tenge. Annual net income - 20 million tenge. To determine the payback period, you must perform the following action:

Thus, the investment will pay off in 2.5 years.

Coefficient of overall economic efficiency of capital investments (E)

where P - annual profit,

K - capital investments.

Payback period (T)

Profit to be:

Profit - difference between income and costs.

Profit on services sold (P) is calculated by the formula:

where B is the planned revenue from the sale of goods or services at current prices (excluding VAT, excises, trade and sales discounts);

C - the total cost of goods or services sold in the coming period.

General formulas for calculating profit.

Gross profit= revenue - cost of goods sold or services

Profit / loss from sales (sales)= gross profit - costs * costs in this case- selling and management costs

Profit / loss before tax= sales profit ± operating income and expenses ± non-operating income and expenses.

Net income (loss= revenue - cost of goods - expenses (managerial and commercial) - other expenses - taxes

Income\u003d revenue (turnover) - cost (or purchase price) of goods or services

Operating profit\u003d gross profit - operating costs * operating costs - the company's costs for processing raw materials and components into a finished product or service

It is one of the important indicators in its evaluation. The payback period for investors is fundamental. It generally characterizes how liquid and profitable the project is. To correctly determine the optimality of investments, it is important to understand how the indicator is obtained and calculated.

The meaning of the calculation

One of the most important indicators in determining the effectiveness of investments is the payback period. Its formula shows for what period of time the income from the project will cover all one-time costs for it. The method makes it possible to calculate the time for the return of funds, which the investor then correlates with his economically advantageous and acceptable period.

Economic analysis involves the use of various methods in the calculation of the above indicators. It is used if comparative analysis to determine the most profitable project. It is important at the same time that it is not used as the main and only parameter, but is calculated and analyzed in conjunction with the rest, showing the effectiveness of one or another investment option.

The calculation of the payback period as the main indicator can be used if the company is aimed at a quick return on investment. For example, when choosing ways to improve the company.

Other things being equal, the project with the shortest return period is accepted for implementation.

Return on investment - a formula showing the number of periods (years or months) for which the investor will return his investment in full. In other words, a refund. At the same time, it should be remembered that the named period should be shorter than the period of time during which the use of external loans is carried out.

What is needed for the calculation

The payback period (the formula for its use) requires knowledge of the following indicators:

• project costs - this includes all investments made since its inception;
• net income per year is the revenue from the implementation of the project received for the year, but minus all costs, including taxes;
• depreciation for the period (year) - the amount of money that was spent on improving the project and methods of its implementation (modernization and repair of equipment, improvement of technology, etc.);
• duration of costs (meaning investment).

And to calculate the discounted return on investment, it is important to take into account:

• receipt of all funds made during the period under consideration;
• discount rate;
• period for which to discount;
• initial investment.

Payback Formula

The determination of the period for the return of investments takes into account the nature of the income from the project. If it is assumed that cash flows are received evenly throughout the life of the project, the payback period, the formula of which is presented below, can be calculated as follows:

Where T is the return on investment;

I - investments;

D is the total profit.

In this case, the total amount of income consists of and depreciation.

To understand how expedient the project under consideration is when using this methodology, it will help that the resulting value of the return on investment should be lower than the one that was set by the investor.

In the real conditions of the project, the investor refuses it if the return period of investments is higher than the limit value set by him. Or he is looking for methods to reduce the payback period.

For example, an investor invests 100 thousand rubles in a project. Project income:

• in the first month amounted to 25 thousand rubles;
• in the second month - 35 thousand rubles;
• in the third month - 45 thousand rubles.

In the first two months, the project did not pay off, since 25 + 35 = 60 thousand rubles, which is lower than the amount of investments. Thus, it can be understood that the project paid off in three months, since 60 + 45 = 105 thousand rubles.

Advantages of the method

The advantages of the method described above are:

1. Ease of calculation.
2. visibility.
3. Possibility to classify investments taking into account the value set by the investor.

In general, according to this indicator, it is also possible to calculate the investment risk, since there is an inverse relationship: if the payback period, the formula of which is indicated above, decreases, the risks of the project also decrease. Conversely, with an increase in the waiting period for a return on investment, the risk also increases - investments may become irretrievable.

Disadvantages of the method

If we talk about the shortcomings of the method, then among them are: the inaccuracy of the calculation, due to the fact that when calculating it, the time factor is not taken into account.

In fact, the proceeds that will be received outside the return period does not affect its period in any way.

In order to correctly calculate the indicator, it is important to understand by investments the costs of formation, reconstruction, and improvement of the fixed assets of the enterprise. As a result, the effect of them cannot come immediately.

An investor, when investing money in the improvement of any direction, is obliged to understand the fact that only after some time he will receive a non-negative value of the cash flow of capital. Because of this, it is important to use dynamic methods in calculations that discount flows, bringing the price of money to one point in time.

The need for such complex calculations is due to the fact that the price of money at the start date of the investment does not coincide with the value of money at the end of the project.

Discounted calculation method

The payback period, the formula of which is presented below, involves taking into account the time factor. This is the calculation of NPV - net present value. The calculation is carried out according to the formula:

where T - the period of return of funds;

IC - investment in the project;

FV - planned income for the project.

This is taken into account and therefore the planned income is discounted using the discount rate. This rate includes project risks. Among them are the main ones:

• inflation risks;
• risks of non-profit.

All of them are defined as percentages and summarized. The discount rate is determined as follows: + all project risks.

If the flow of money is not the same

If the revenue from the project is different every year, the cost recovery formula discussed in this article is determined in several steps.

1. First, it is necessary to determine the number of periods (moreover, it must be an integer) when the amount of profit on a cumulative total becomes close to the amount of investments.
2. Then it is necessary to determine the balance: from the amount of investments, we subtract the amount of the accumulated amount of income from the project.
3. After that, the value of the uncovered balance is divided by the value of cash inflows of the next period of time. The main economic indicator in this case is the discount rate, which is determined in fractions of a unit or as a percentage per year.

conclusions

The payback period, the formula of which was discussed above, shows for what period of time a full return on investment will occur and the moment will come when the project will begin to generate income. The investment option with the shortest return period is selected.

For the calculation, several methods are used, which have their own characteristics. The simplest is to divide the amount of costs by the amount of annual revenue that the funded project brings.

The payback period of an investment project is the most popular indicator for evaluating the feasibility of investments.

The simplicity of the calculation and its clarity contributes to this popularity. Indeed, if an investor is informed that in a year his investments will be returned to him, and then he will receive dividends from the project, he understands that it is worth investing in the project, even without being interested in the size of dividends.

Being a static indicator, it shows the investor, up to a month, the return period of his investment in the project.

This indicator is also used to select an investment option, of several options, preference is given to the project with the shortest payback period.

The payback period of an investment project is the ratio of the initial investment in the project to the average annual profitability of the project. If there are several investors, then each calculates the payback period of his investments in investment project, i.e. the ratio of his investment in the project to his average annual income in this project.

The calculation of the payback period of an investment project is carried out according to the formula:

• PP - payback period in years;
• Io - initial investment in the project in rubles;
• CFcr - average annual income of the project in rubles.

Since it is not always possible to determine the average annual income, the calculation of the payback of an investment project is carried out according to the formula:

• CFt - receipt of income from the project in the t-th year;
• n is the number of years.

The payback period can be calculated in months or even days.

Below is an example of calculating the payback period for an investment in a restaurant:

Change from red (losses) to green color(profit) in the final line of the calculation shows the payback period of this project, which is 7 months.

If the cash flow from the investment is not relevant, i.e. during the evaluation period of the project, there are years that bring loss, then the calculation of payback becomes impossible.

It will not reflect the true return on investment.

The above figure does not take into account the time value of money. Money in each specific period has its own price, which depends on many factors; inflation in the country, the cost of loans, the efficiency of the economy, etc. Therefore, in calculating the effectiveness of investments, the value of money in future periods is taken into account and their value is brought to a specific point in time (the time of evaluation). This process is called discounting. The calculation of payback can be carried out taking into account discounting cash flows. This specifies the payback period and is determined by the formula:

DPP = n if

• DPP - payback period, taking into account the cost of money;
• r - Discount factor in the form of an interest rate for recalculating cash flows into the value of the present value of money.

From the calculation formulas of the discounted payback period, it can be seen that it will always be greater than the static payback period. This is demonstrated by the following calculation:

DPP is 8 months.

Both of these indicators (PP and DPP) have a common drawback, they do not take into account cash flows after the investment payback period. And the cash flows after the return on investment can change the investor's opinion about the effectiveness of the project. Therefore, return on investment indicators are auxiliary indicators in assessing the effectiveness of investment projects, where the main indicators are the present net value of the investment project (NPV), the internal rate of return of the investment project (IRR) and the return on investment (PI).

If two or more projects have the same key indicators, the payback period of the investment project is used to make the final decision on the choice of option.

But sometimes it is more important for an investor to receive his investments in a project in a short time, then the main indicator is the payback period.

The payback period significantly depends on the start of investment and the presence of "windows" in the investment process. Such kind of stops (technological and forced) in the process of implementing an investment project increase the payback period. For example, in the process of investing in an object under construction, the time between pre-investment costs and the costs of the actual construction can be up to two years, which significantly increases the payback of the project.

In general, indicators of the payback periods of investment projects are useful and necessary elements calculation of indicators of their effectiveness. Their calculation is not difficult and does not require complex methods; therefore, despite their shortcomings, they will continue to serve as a guideline for evaluating and determining the feasibility of investment projects.

If you have ever thought about starting a business, then one of the most important problems that worried you would be profit. It is this indicator that forms the profitability of the business.

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After all, not only the net income of the client depends on it, but also the payback period of the enterprise. That is, the time for which you will return the money that you invested in this company or a firm. This indicator is used not only for firms. It is also popular when calculating investments on investments. Let's figure out how to correctly calculate the payback period of the company and how important this indicator is.

Definition

A simple period for which an investment or money invested in a business pays off- this is the period from investing funds to the moment when they return. It should be noted that not all funds received are considered. And just so to speak clean. That is, this is the moment when the first financial transactions were made, and then the duration until they returned in the form of net income.

When drawing up a business plan, obtaining a franchise or a loan to start a business, one of the most important points is the payback period of the project or investment.

So the payback- this is the period for which the number of income will become greater than the figure and costs, and thus block them. If we take into account the fact that some businesses require constant investment, as well as the fact that income is very unstable and changeable, it can be argued that the payback period is a very relative value that remains dynamic at any time.

That is, if income and expenses are applied to the coordinate axis and displayed as a straight line, the OY axis as a monetary value, and OX as time, then we will get a graph. The place where the straight line crosses the OH will be considered the beginning of full payback.

What is a discount period?

If you need to calculate the payback period of not just a business, but cash investments, it is best to use an indicator that has a name - the discounted payback period. This value also shows the time required for the full return of investment money.

Its only difference is that it takes into account the value of money, which changes over time, that is, inflation. It is useful because, unlike the usual payback period, this value takes into account financial risk more accurately, because it takes into account the possibility of inflation.

It is thanks to him that you can compare prices this year, as well as those that will be with the full payback period.

But, it is worth noting that since inflation is an approximate and unstable value, this indicator is dynamic, and therefore its exact calculation is also impossible and may be with deviations.

The only drawback that payback in terms of present value has is that the value does not take into account the amount of money invested after the full payback period has passed.

What do you need to know to calculate the payback of an investment project?

1. Project costs- this includes all cash investments that have been made since the beginning.
2. Net profit for the year- this is the money that the object will receive in a year, already excluding taxes and other costs.
3. Depreciation per year- this is the amount that the object will spend on improving its project (updating equipment, etc.).
4. The duration of the investment.

1. The receipt of all funds that were made for a certain period of time.
2. The discount rate for money.
3. The period for which they were discounted.
4. The original investment that was invested.

1. Discount rate.
2. The period of the beginning of the input of money into the investment project.
3. The period for evaluating these investments, as well as their profits.

How to calculate?

1. Many sites offer various online resources for calculating the payback period. According to experts, this site http://www.online-electric.ru/econom/338.php is the most convenient when summing up and calculating the payback period. Upon entering the site, you will see a form in which you need to enter your data, such as the cost of your investment in a business or investment project, the share of profit you receive, the amount of depreciation you spend, and the discount rate. After you fill out this form in rubles, it will give you values ​​in time, which will mean the payback period of this project.
2. Also, this indicator can be calculated in EXCEL, but this is where things get a little more complicated. So, you will need to make a table where you write down the number of years, the amount of investments, cash flows and net cash flows. After that, you will need to enter a formula that will give you the values ​​of the net discounted flow. In a cell where the value will cease to be negative and there will be your payback period. Calculating the indicator in this way is a bit more complicated, but it immediately prepares visual material for you if you need it.
3. And probably the most in the usual way there will be a calculation given value manually. To do this, we will take the formula: the period for which the investment will pay off = the costs of the project / the net income that is received + the depreciation that was spent per year + the duration of the investment. Or you can use the formula: discounted payback period = income from received funds for a certain period / (1 + percentage of discounted income) period ≥ initial investment.

Example

Let's imagine that you open your own project, which requires investment investments for about a year, as well as an initial investment of 150,000 rubles. Every year, investors will receive 50,000.

So, after doing the calculations, we get:

According to the table, we see that the payback period of the project is exactly 5 years.

Factors affecting the payback period

Experts identify two types of factors that can affect the payback period of an investment project:

1. External These are factors that the owner has almost no control over. These include:
   • renting premises, which increases costs and thereby reduces income; if the initial capital is taken on credit, it is worth considering the period of its return;
   • unforeseen expenses, or emergencies that require cash investments;
2. Domestic expenses- these are those that are entirely dependent on the owner and the business. So, depending on the type of strategy that the boss chooses, we can talk about different costs within the company. The main ones include energy efficiency, as well as durability.

The payback period is the period of time it takes for the initial investment to pay off. The payback period is expressed in years or parts thereof. For example, if a company invests $300,000 in new production, and then this production brings in $100,000 per year, then the payback period will be 3.0 years (300,000% initial investment / $100,000 annual payback). with a shorter payback period is better, since the investor's initial costs are at risk for a shorter period of time. The calculation used to obtain the payback period is called the payback method. This is one of the most simple methods investment appraisals. But unlike other formulas, this one does not include the calculation of subsequent profits.

The essence of a simple formula

The payback formula is quite simple. Divide the cash costs (which are supposed to be invested at the beginning of the project) by the amount of net income from the project per year (which is supposed to be the same). Mathematically it looks like this:

If the cash inflow is intermittent, then you must calculate the total cash flow for each period and then use the following formula for the payback period:

Where B is the absolute value of the total cash flow at the end of period A, and C is the total cash flow in the subsequent period.

Payback period calculation in Excel

Prior to Excel 2013, there were no "native" financial functions in this program to calculate the payback period. In 2012, author Abraham A. released a library of financial functions in Excel called the TadXL add-on. This add-on has a lot of financial features that Microsoft hasn't yet offered.

Using tadXL functions such as tadPP, finding payback periods in Excel 2007, 2010 and 2013 is very easy. Let's take the cash flows from our previous investments, to find the payback period in Excel, you must enter the following command: =tadPP((-100, 60, 60, 60, 60)) 1.666666667 or =tadPP(A1:E1) .

If you are interested in looking for a realistic payback period, look for a period of time when all costs will recover. For example, the movement of investment funds was -150, 60, 60, 60, -50, 60, where there is an intermediate outgoing volume of 50 million. To find the payback period in Excel, use the functions from tadXL, called tadTPP, where TTP is payback period. Like this: = tadTPP ((-150, 60, 60, 60, -50, 60)) 4.333333333 . Now the payback period is quite different from early investments where you were only concerned with recovering the original value.

Payback period. Example

A lumber company is considering purchasing a $50,000 band saw that will generate $10,000 in net profit. The payback period for these capital investments is 5.0 years. The company is also considering buying a $36,000 conveyor belt that will cut the cost of the saw by at least $12,000 a year. The payback period, in this case, will be 3.0 years. If the company has sufficient funds to invest in one of these projects, and if only the payback method was used for the solution, then buying a conveyor belt would be a better solution.

payback method. Advantages and disadvantages

The calculation of the payback period is useful from the point of view. Because he calculates the amount of time that the initial investment will be at risk. If you were to analyze prospective investments using the payback method, you would generally choose those investments that have a quick payback period and reject those that have a longer one. This is useful in industries where the investment quickly becomes obsolete, and where a full return on the initial investment would therefore be a major problem.

Although the payback method is widely used due to its simplicity, it has the following disadvantages:

1. Lack of duration. The life of the asset expires immediately after the initial investment pays off, that is, there is no opportunity to receive additional cash flows. The payback method does not provide for the lifespan of the assets.
2. Additional cash flows. The concept does not consider the presence of any additional cash flows that may arise as a result of investments in periods after full payback.
3. Profitability. The payback method focuses solely on the time it takes to recoup the initial investment. That is, it does not track the final profitability of the project at all. Thus, the method may mean that a project with a short payback period, but no overall profitability, is better than a project requiring a long-term payback period, but having a significant, long-term profitability.

Why is a short payback period better than a longer one?

Under equal conditions, an investment that pays off in a short period of time will be better because:

• Investment or operating costs are recovered sooner and are more likely to be available for further use.
• A short payback period is less risky.

It is generally believed that the longer the time needed to cover the funds, the more uncertain are the positive results. For this reason, the payback period is often seen as a measure of risk, or a risk criterion that must be met before the funds are spent.

The payback formula is used for quick calculations and generally should not be used as the sole criterion for approving an investment. But it is a useful tool.