How it’s calculated
The payback period is the time needed for an investment's cash inflows to add up to its cost. With equal yearly inflows it is a single division. With uneven inflows, add them year by year until the running total reaches the cost; the fraction of the final year assumes its cash arrives evenly through that year.
Example (OpenStax Principles of Managerial Accounting 11.2): a printer costs $150,000 and brings in $20,000 net cash per year. Payback = 150,000 ÷ 20,000 = 7.5 years. Uneven example from the same section: a $40,000 investment returning $10,000, $10,000, $5,000, $5,000, then $7,500 a year has recovered $37,500 after 5 years, so payback = 5 + 2,500 ÷ 7,500 = 5.33 years.
Payback ignores the time value of money and anything after the payback date, so it is best used as a quick screen alongside NPV and IRR.
Frequently asked questions
What if my cash flows run longer than six years?
Use the even mode with an average inflow for a rough figure, or add the inflows year by year yourself. The NPV calculator also accepts uneven flows.
Is a shorter payback always better?
Shorter payback means less risk of not recovering your money, but a project with a longer payback can still be worth more overall. Check NPV too.
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Sources
- Principles of Managerial Accounting, 11.2 Evaluate the Payback and Accounting Rate of Return in Capital Investment Decisions — OpenStax
- Principles of Finance, 16.1 Payback Period Method — OpenStax
Formulas are taken from the free public references above. Results are provided “as is” for informational and educational purposes only. See our disclaimer.
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