Project Management

What is Payback Period?

From the The Money Files Blog
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What is Payback Period?

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payback period

Payback period is a term that you’ll seen on business cases and in other project selection documentation. It’s a criteria that helps organisations decide if they want to go ahead with a project or not.

But what is it? And how can we use it to our advantage?

Payback period refers to the amount of time required for your investment to pay back. In other words, it’s the time taken to ‘earn’ the amount of the original investment.

Let’s say you own a hotel. You build a penthouse room on the top. It costs £100,000 to build (you get the materials very cheaply! Go with me, this amount makes the maths easier).

The price for one night’s accommodation in the penthouse is £100.

Therefore, you need to sell 1,000 nights of accommodation to break even.

 100,000 / 100 = 1,000.

The payback period for this room is 1,000 nights.

That example is SO simplistic but hopefully you get the idea. Payback period measures how long something takes to pay for itself.

What kind of payback period is best?

The best kind of payback period is the shortest!

The faster something can pay back, and start bringing in profit, the better in business terms. Once you have broken even, payback period has been completed and any money earned after that is extra – the benefits you were hoping to see.

I love using payback period because it’s easy to understand and easy to work out. If you are comparing projects, when everything else is equal, the project with the shortest payback period should be the one you do first.

Of course, in real life projects aren’t equal in all other respects. You will be juggling a range of other selection criteria, of which, payback period is only one. However, it is a useful measure to look at first, to give you an idea of the effort involved in earning anything from this project. Something that has a payback period of over 10 years might not be worth doing at all and can be eliminated from project selection.

Depending on your industry, payback periods could be short or long. Any type of large-scale construction project will necessarily have a longer payback period than launching a fast-to-market consumer app. Some projects may not pay back for years, and still be worth doing. You know your industry and projects better than I ever will, so apply your professional judgement and consider what the ‘appropriate’ kind of payback period is for your organisation.

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payback period

Posted on: March 11, 2020 09:00 AM | Permalink

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Great and basic information for new investors.

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