The project payback formula is one of the important indicators in its evaluation. The payback period for investors is fundamental. It generally characterizes how liquid and profitable the project is. To correctly determine the optimality of investments, it is important to understand how the indicator is obtained and calculated.
The meaning of the calculation
One of the most important indicators in determining the effectiveness of investments is the payback period. Its formula shows for what period of time the income from the project will cover all one-time expenses for it. The method makes it possible to calculate the time for the return of funds, which the investor then correlates with his economically viable and acceptable term.
Economic analysis involves the use of various methods in the calculation of the mentioned 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 used as the main and only parameter, but is calculated and analyzed in conjunction with the others, showing the effectiveness of a particular investment option.
Calculation of the repayment period as the main indicator can be applied if the company is aimed at a quick return on investment. For example, when choosing ways to improve the company.
All other things being equal, the project with the shortest return period is accepted for implementation.
Return on investment - a formula that demonstrates the number of periods (years or months) for which the investor will return his investments in full. In other words, this is a refund period . It should be remembered that the named period should be shorter than the length of time during which the use of external loans is carried out.
What is needed for calculation
The payback period (formula for its use) involves the knowledge of such indicators:
- project costs - this includes all investments made from 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 methods for its implementation (modernization and repair of equipment, improvement of equipment, etc.);
- the duration of the costs (meaning investment).
And to calculate the discounted term return on investment, it is important to take into account:
- the receipt of all funds made for the considered period of time;
- discount rate;
- period for which to discount;
- initial investment amount.
Payback formula
The period of return on investments is determined taking into account the nature of the receipt of net income for the project. If it is understood that cash flows uniformly throughout the project, the payback period, the formula of which is presented below, can be calculated as follows:
T = I / D
Where T is the term return on investment;
And - investments;
D - the full amount of profit.
In this case, the full amount of income consists of net profit and depreciation.
To understand how appropriate the project in question is when using this technique, it will help that the value of the return on investment should be lower than that set by the investor.
In real conditions of the project, the investor refuses it if the return on investment period is higher than the limit set by him. Or he is looking for methods to reduce the payback period.
For example, an investor invests 100 thousand rubles in a project. Income from the implementation of 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 of investments. Thus, it can be understood that the project paid off in three months, since 60 + 45 = 105 thousand rubles.
Method Advantages
The advantages of the method described above are:
- Ease of calculation.
- Visibility.
- An opportunity to classify investments taking into account the value set by the investor.
On the whole, it is possible to calculate the risk of investments by this indicator, since there is an inverse relationship: if the payback period, the formula of which is indicated above, decreases, the risks of the project also decrease. And vice versa, with the growth of the investment payback period, the risk also increases - investments may become irrevocable.
Disadvantages of the method
If we talk about the shortcomings of the method, then the following are distinguished: inaccuracy of calculation, since the time factor is not taken into account when calculating it.
In fact, the revenue that will be received abroad of the repayment term does not in any way affect its term.
In order to correctly calculate the indicator, it is important by investment to mean the costs of the formation, reconstruction, improvement of fixed assets of the enterprise. As a result, the effect of them cannot occur momentarily.
When an investor invests in improving a certain direction, he is obliged to understand the fact that only after some time he will receive a non-negative value of the cash flow of capital. Because of this, it is important to use dynamic methods in calculations that discount flows, bringing the price of money to one point in time.
The need for such complex calculations is due to the fact that the price of money at the start date of the investment does not coincide with the value of money at the end of the project.
Discounted Calculation Method
The payback period, the formula of which is presented below, involves taking into account the time factor. This is a calculation of NPV - net present value. The calculation is carried out according to the formula:
T = IC / FV,
where T is the refund period;
IC - investment in the project;
FV - the planned income for the project.
It takes into account the value of future money, and therefore the estimated income is discounted using the discount rate. This rate includes project risks. Among them, the main ones can be distinguished:
- inflation risks;
- country risks ;
- non-profit risks.
All of them are determined as a percentage and summarized. The discount rate is determined as follows: risk-free rate of return + all risks of the project.
If the cash flow is not the same
If the revenues from the project are different each year, the cost recovery, the formula of which is considered in this article, is determined in several steps.
- First, it is necessary to determine the number of periods (moreover, it must be an integer) when the amount of profit on an accrual basis becomes close to the amount of investments.
- Then you need to determine the balance: from the amount of investments we subtract the size of the accumulated amount of income from the project.
- After that, the value of the uncovered balance is divided by the value of the cash inflows of the next period of time. The main economic indicator in this case is the discount rate, which is determined in fractions of a unit or in percent per year.
conclusions
The payback period, the formula of which was considered above, shows how long a full return of investments will take place and the moment will come when the project will begin to generate income. The investment option is selected for which the return period is the shortest.
For calculation, several methods are used that have their own characteristics. The simplest is dividing the amount of costs by the amount of annual revenue that the funded project brings.