Payback is a term that is often used by business managers. But many people may have doubts about what it really means. The use of foreign words is very common, especially in the business world.
Payback is just one of them and it is very important for the company's finances.
Find out what payback is and how to calculate it!
What is payback?
Payback means “return”. It is a strategy, an indicator used in companies to calculate the return period of investment in a project.
In more technical terms, payback is the return time from the initial investment until the moment when the accumulated returns become equal to the value of that investment.
Payback gives the manager an estimate of how long it will take until they recover their initial application.
This period is not always short – it depends on the value of the investment and the type of business. Generally, the return occurs within months or years.
Payback is related to other indicators such as:
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ROI (Return on Investment): percentage of return on the initial investment;
NPV (Net Present Value): accumulated value of the cash flow, used for the exact calculation of payback.
IRR (Internal Rate of Return): interest rate for which the NPV becomes zero.
What are the advantages and disadvantages of payback?
Like any strategy, payback has its positive and negative points. The big secret is knowing how to use it correctly. Its advantages include:
It presents a simple formula, easy to apply and learn;
It provides an idea of the level of liquidity of the business and the level of risk involved;
It can be especially useful in two cases: in projects with a very high degree of risk and in projects with a limited life;
In times of financial crisis and economic instability, the resource serves to increase business security.
Disadvantages include:
The indicator values differently the flows received in different periods (that is, according to dualistic thinking, before or after the payback, disregarding the values received within each of these intervals);
For longer duration projects, the resource is not highly recommended, as it does not consider the cash flows produced after one year of recovery.