The payback period starts from the time of the initial investment and lasts until the investment's costs are fully recovered by the income or cash inflows generated by the investment. It marks the point at which the investment breaks even and begins to pay back the initial outlay.
Explanation of Payback Start
- The payback period begins at the date or time when the initial investment (or project cost) is made. From this point, the calculation accumulates the net cash flow (cash inflows minus outflows) over time.
- The payback period ends once the cumulative cash flows equal the initial investment cost, meaning the investment has "paid back" or recovered its value.
- This period can be expressed in years, months, or other units consistent with the cash flow timing.
How the Payback Period is Used
- It helps investors and businesses determine how long it will take before starting to profit from an investment.
- Shorter payback periods are generally preferred as they imply quicker recovery of invested capital and reduced risk.
- It is a straightforward measure used in business and project management to evaluate investment feasibility.
Summary of Calculations
- Simple payback period formula:
Payback Period=Initial InvestmentAverage Annual Cash Flow\text{Payback Period}=\frac{\text{Initial Investment}}{\text{Average Annual Cash Flow}}Payback Period=Average Annual Cash FlowInitial Investment​
- Discounted payback considers the time value of money, making payback periods typically longer.
In essence, payback starts at the moment of the initial investment and ends when cumulative cash inflows have recovered that investment cost, indicating the investment has broken even and is beginning to generate profit.
