what is payback period

The payback period is a financial metric used to determine the amount of time it takes to recover the cost of an investment or to reach the break-even point. It is calculated by dividing the cost of the investment by the annual cash flow until the cumulative cash flow is positive. The payback period is expressed in years and fractions of years. The payback period is often used as an analysis tool because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavor. However, one of the downsides of the payback period is that it disregards the time value of money. The appropriate timeframe for an investment will vary depending on the type of project or investment and the expectations of those undertaking it. The payback period can help investors decide between different investments that may have a lot of similarities, as they’ll often want to choose the one that will pay back in the shortest amount of time. The longer the payback period, the higher the risk. The payback period is useful from a risk analysis perspective, since it gives a quick picture of the amount of time that the initial investment will be at risk. If you were to analyze a prospective investment using the payback method, you would tend to accept those investments having rapid payback periods and reject those having longer ones.