What is a payback period?
Payback period tells us the time it takes for the project to repay the original spend. This is usually quoted in months or years and is part of the ROI measures for a particular project. The payback period compares the money spent to buy the equipment or services needed for a project against the amount of time it takes for the amount spent to be covered.
Calculating a payback period can benefit your business in many ways. Knowing how long it will take to get your money back is an important factor to know when investing in a project. You will be able to consider whether the time period for payback is too long as well as whether the investment may be too complex for it to be possible to gain back the money spent in the time needed.
The payback period is a very simple calculation that doesn’t include any complicated mathematical operations. It is based on the cash values of the costs and benefits. Depending on your cash flow, there are two ways to calculate the payback period - the averaging method and the subtraction method. If your cash flow is going to be steady and you know you will be paying back the same amount every month or year, then the averaging method is used to calculate how long the payback period will be. For this you divide the annual expected cash flow by the initial expenditure for the project. If you know your cash flow will be varied over the payback period, for example you may have a bigger sum for one month than the next, then the subtraction method is used. For this you subtract each individual monthly or yearly cash inflow from the initial cash outflow until the money has been paid back.
The results from the payback period can vary and it is possible to get multiple payback values. One payback result is to gain the same sum of money back every month until the payback period ends, or you may receive the total sum of money all at once after a certain period of time. Another way is to receive multiple payback values, this involves the net cashflow crossing the zero line multiple times over the payback period due to other recurring costs needing to be spent. However, eventually this will pay back all costs over the time period set.
You should not rely solely on payback periods when creating a business case, it is best to also include the NPV and IRR values to emphasise the value and rate of return and to avoid any doubts that may arise from the customer. Shark ensures to deliver seamless and transparent handling of your payback period calculations by creating individual monthly cash flows for each benefit and cost. To correctly calculate your payback period Shark also ensures to accurately manage the timing of the costs and benefits in your project which is key when creating and presenting a business case to gain customer sponsorship.
For more information about payback read Payback Explained.
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