Payback Period Calculator

Free online Payback Period Calculator. Instantly calculate simple payback period, discounted payback period, and cash flow return rate. Supports irregular cash flows.

Irregular cash flow every year

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The Payback Period Calculator Explained: How Long Does It Take to Reclaim an Investment?

When considering a new investment in finance or business, the most common question for each investor, owner of a business, or financial manager is usually the same: “When do I see my money?”

The answer is provided by a payback period. The payback period is one of the simplest yet most useful financial concepts that can aid you in making well-informed capital budgeting decisions. For example, if you are considering investing in new equipment for your production facility, launching a marketing initiative, installing solar energy systems at home, or doing research and development on startup ideas, the payback period gives you key indicators as to how much risk you're taking, how liquid your investment is, and how quickly you can expect it to generate returns.

This complete guide covers all aspects of the payback period and how the discounted payback period works, as well as several practical examples, equations to calculate both payback periods (standard vs discounted), advantages and disadvantages of both, and how you might be able to use either method to create your own calculator to facilitate more informed financial decisions. After completing this guide, you will have a good understanding of how to use, or even create, your own payback period calculator.

The Role of Cash Flow in Payback Period Calculations

While payback periods are very important, the foundation for all payback calculations is cash flow. Cash flow represents the actual flow of cash into and out of a company (or project). Cash flow does not equal income (accounting profit) which may include non-cash items such as depreciation.

Cash flows can be classified into two main categories: positive cash flow (money coming in, e.g., revenue, savings and returns) and negative cash flow (money going out, e.g., initial investment and operating expenses).

In terms of calculating payback periods, we are concerned with total cash flow (Net Cash Flow), which is made up of inflows less outflows. Net Cash Flow is usually expressed in terms of how much positive cash flow has been created from the initial investment.

Let's say that you invest $100,000 in equipment today (-$100,000 in Year 0) and the equipment generates $30,000 in additional annual profit. You generate a total cash inflow of $30,000 in cash flow each year while owning that equipment.

Clear enough? Remember that today's dollar value will always be greater than the dollar value of the same dollar in the future, and thus, you will need to calculate the Present Value of all future cash flows (Future Cash Flows).

Discounted Cash Flow (DCF): Accounting for the Time Value of Money

The time value of money is a core financial principle: a dollar today is worth more than a dollar tomorrow because today's dollar can be invested to earn interest.

Discounted Cash Flow (DCF) adjusts future cash flows to their present-day value using a discount rate (usually the cost of capital, required rate of return, or WACC).
The basic formula for the present value (PV) of a future cash flow is:
PV = Future Cash Flow / (1 + Discount Rate)^Number of Periods
Example:
$30,000 received in year 1 with a 10% discount rate - PV = 30,000 / (1.10)^1 = $27,272.73
The same $30,000 in year 5 - PV = 30,000 / (1.10)^5 = $18,627.64This is why the discounted payback period is almost always longer than the regular payback period — future money is worth less today.

Definition of Payback Period as well as a Payback Period Formula

A payback period is defined as the number of years it takes for an investment to recoup its investment amount via cumulative annual cash inflows. The payback period answer the questions: "When am I going to hit break-even?"

Typical Payback (For Regular Cash Inflows):
Payback Years = Initial Investment divided by Average Annual Inflow.

Payback Period =

Initial investment Cash flow per year

Example: Initial Investment: $100,000
Annual Inflow: $25,000
Calculating Payback Years
Payback Years = $100,000 / $25,000 = 4 years.
Typical Payback (For Irregular or Uneven Cash Inflows):
For this example, we will need to account for averaging cumulative cash flows year after year (as is true in most cases).
You will want to keep track of cumulative cash flows from Year 1 through Year 5.
You will find that at Year 5 your cumulative cash flows will exceed the $100,000 investment amount.
After locating the year that cumulative annual inflows exceed cumulative investment, you will use interpolation to determine the percent of that year remaining with:
Payback Period = Years before full recovery + (Remaining amount to recover / Cash flow in recovery year)
Example of Payback Years:
Total Initial Investment is $100,000.
Cash Flow Amounts by Year for 5 Years with Cumulative Cash Flows:
Year 1 = $10,000 | Year 2 = $20,000 | Year 3 = $30,000 | Year 4 = $40,000 | Year 5 = $50,000
Cumulative Cash Flow Amounts Yearly:
End of Year 1 = $10,000;
End of Year 2 = $30,000;
End of Year 3 = $60,000;
End of Year 4 = $100,000; which equates to 4 years exactly.
If cash flow for Year 4 was $45,000, cumulative cash flow would be $105,000, and payback would equal 3 + (40,000/45,000) = 3.89 years.
Investments with shorter payback years are less risky; this is especially important for businesses that do not have enough cash to sustain operations for many years in a row.

Discounted Payback Period:

As originally described, the Discounted Payback period is a well-established method of capital budgeting, which focuses on estimating the length of time required to recoup an initial cash outflow using discounted cash inflows, and factoring in the time value of money through the use of a discount rate.
The Discounted Payback Period Formula Incorpates Discounting Into The Calculation of Cash Flows over Time

1. Calculate the Present value of all cash flows In Each Year
2. Continually Accumulate Cash Flows Until They Match Or Exceed The Original Investment
3. Interpolate The Year As Required (For Exact Calculation) Example: (Same Example as Above) Initial Investment $100,000 , Using A 10% Discount Rate, Annual Cash Flows $25,000 (Net Present Value = $100,000)

DCFt =

CFt (1+r)t

CF_t = Cash Flow in year _t
r = Discount rate
t = Time period (year)

Recovery happens between year 5 and 6
Discounted Payback = 5 + (5,231 / 14,112) ≈ 5.37 years
Notice: It's longer than the simple payback (4 years) because future money is worth less.

Advantages and Disadvantages: Payback vs Discounted Payback

Payback Period — Pros & Cons
Advantages:
Extremely simple and intuitive
Emphasizes liquidity and quick capital recovery
Great for high-risk or fast-changing industries
Useful as a first screening tool
Disadvantages:
Ignores time value of money
Completely disregards cash flows after payback
Can favor short-term projects over more profitable long-term ones

Discounted Payback Period — Pros & Cons

Advantages:
Accounts for time value of money → more accurate
Still relatively easy to understand and calculate
Better for comparing projects with different cash flow timings
Disadvantages:
Still ignores cash flows after payback
Requires estimating a discount rate (subjective)
Slightly more complex than basic payback
Many experts recommend using both together, alongside NPV and IRR, for a complete picture.