Payback period: the formula. Investment and profit

The project payback formula is one of the important indicators in its evaluation. The payback period for investors is fundamental. He as a whole characterizes the extent to which the project is liquidated and profitable. To correctly determine the optimality of investments, it is important to understand how the indicator is obtained and calculated.

Sense of calculation

One of the most important indicators in determining the effectiveness of investment - the payback period. The formula shows how much time a project's revenue will cover all the one-time costs for it. The method makes it possible to calculate the time of repayment of funds, which then the investor correlates with its economically viable and acceptable term.

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

The calculation of the repayment period as the main indicator can be applied if the enterprise 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 smallest period of return is accepted for implementation.

Return on investment - a formula that shows the number of periods (years or months) for which the investor will return its investments in full. In other words, this is the period of the refund. It should be remembered that this period should be shorter than the length of time during which external loans are used.

What is needed to calculate

The payback period (the formula of its use) assumes knowledge of such indicators:

• Project costs - this includes all the investments made since its inception;
• Net income per year is the revenue from the project, received for the year, but minus all costs, including taxes;
• Depreciation for the period (year) - the amount of money spent on improving the project and the methods of its implementation (modernization and repair of equipment, improvement of equipment, etc.);
• Duration of costs (there are investment funds).

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

• The arrival of all funds made during the period under review;
• Discount rate;
• Period for which to discount;
• The initial amount of investment.

The formula for calculating the payback

Determination of the period of return of investments takes place taking into account the nature of the receipt of net income for the project. If it is understood that the cash flows flow evenly throughout the project's lifetime, the payback period, the formula of which is presented below, can be calculated as follows:

T = I / D

Where T is the period of investment return;

And - investments;

D - the total amount of profit.

In this case, the total amount of income is composed of net profit and depreciation.

To understand how advisable the project in question is when using this methodology, it will help that the received amount of the return period of the invested funds should be lower than that set by the investor.

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

For example, the investor invests 100 thousand rubles in the project. Income from the project:

• 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 invested. Thus, it can be understood that the project paid off in three months, since 60 + 45 = 105 thousand rubles.

Advantages

Advantages of the method described above are:

1. Simplicity of calculation.
2. Visibility.
3. The opportunity to classify the investment taking into account the investor's assigned value.

In general, in this indicator it is possible to calculate the risk of investment, since there is an inverse relationship: if the payback period, the formula of which is indicated above, is reduced, the risks of the project are also reduced. Conversely, as the waiting time for investment returns increases, the risk increases as well - investments can become irrevocable.

Disadvantages of the method

If we talk about the shortcomings of the method, we distinguish among them: the inaccuracy of the calculation, in view of the fact that during its calculation the time factor is not taken into account.

In fact, the proceeds that will be received abroad for the period of return, in no way affect its term.

In order to correctly compute the indicator, it is important to use investments to mean the costs of forming, reconstructing, improving the fixed assets of the enterprise. As a result, the effect from them can not occur momentarily.

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

The need for such complex calculations is caused by the fact that the price of money on the date of the beginning of investment does not coincide with the value of money at the end of the project.

Discounted calculation method

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

T = IC / FV,

Where T is the period of the refund;

IC - investment in the project;

FV - projected revenue for the project.

Here, the cost of future money is taken into account, and therefore the planned income is discounted using a discount rate. This rate includes project risks. Among them, the main ones are:

• Risks of inflation;
• Country risks ;
• Risks of non-return.

All of them are determined in percentages and are summed up. The discount rate is defined as follows: risk-free rate of return + all risks for the project.

If the flow of money is not the same

If the income from the project is different each year, the cost recovery, the formula of which is considered 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 by the cumulative total becomes approximate to the amount of investments.
2. Then you need to determine the balance: from the amount of investments subtract the size of the accumulated value of the proceeds of the project.
3. After that, the amount of the uncovered balance is divided by the amount of cash inflows of the next time interval. The main economic indicator in this case is the discount rate, which is determined in fractions of a unit or in percents per year.

conclusions

Payback period, the formula of which was considered above, shows for what period of time there will be a full return of investments and there will come a time when the project will start to yield income. Select the option of investment, in which the return period is the smallest.

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