While starting any business venture or introducing any new product in the market, it is important to determine its payback period. The simple definition of payback period is the time that will be required for the initial investment to recover with the help of cash flow generated by business. In any business study, the first deciding point of launching any product is its payback period.

Calculating payback period is really easy and there is a very simple formula that you can use to calculate payback period given initial cost and cash inflow.

Let’s assume that the cash inflow for each payback period even which makes it really easy to calculate the payback period with the help of following formula.

In case if the cash inflow per period is uneven then we will have to use a different formula to calculate payback period. The formula for uneven cash inflow is given below;

The variables used in above formula are described below;

• A: Last period with a negative cumulative cash flow

• B: Absolute value of cumulative cash flow at the end of the period A

• C: Total cash flow during period A

With the help of following examples, you will be able to get a better understanding of above mentioned formulas.

Let’s assume that Company A is deciding to undertake a project that requires an initial investment of $100 million. The expected per annum income generated by project is estimated to be $25 million for next 7 years. The payback period of this project can be calculated by using the even payback period formula.

Payback Period = Initial Investment / Annual Cash Flow

Payback Period = $100M/ $25M

Payback Period = 4 Years

In above example, the project will recover its initial investment in first four years and the income generated in next three years will be considered as profit.

Let’s assume, Company A is taking a decision that involves undertaking a project that requires initial investment of $50 million and the expected income generated by project is $10 million for first year, $13 million for second year, $16 million for third year, $19 million for fourth year and $22 million for fifth year. The payback period of this project can be calculated with the help of uneven payback period formula as discussed above.

(cash flows in millions) Cumulative

Cash Flow

Year Cash Flow

0 (50) (50)

1 10 (40)

2 13 (27)

3 16 (11)

4 19 8

5 22 30

Payback Period

= 3 + (|-$11M| / $19M)

= 3 + ($11M / $19M)

≈ 3 + 0.58

≈ 3.58 years

It is really easy to calculate payback period for any project once you know about the initial investment and cash inflow values. Investors often use this method to determine whether it will be fruitful to invest their money in a particular project or not.

Calculating payback period is really easy and there is a very simple formula that you can use to calculate payback period given initial cost and cash inflow.

**Payback Formula**Let’s assume that the cash inflow for each payback period even which makes it really easy to calculate the payback period with the help of following formula.

**Payback Period = Initial Investment / Cash inflow per period**In case if the cash inflow per period is uneven then we will have to use a different formula to calculate payback period. The formula for uneven cash inflow is given below;

**Payback Period = A + B/C**The variables used in above formula are described below;

• A: Last period with a negative cumulative cash flow

• B: Absolute value of cumulative cash flow at the end of the period A

• C: Total cash flow during period A

With the help of following examples, you will be able to get a better understanding of above mentioned formulas.

**Example 1:**Even Cash FlowsLet’s assume that Company A is deciding to undertake a project that requires an initial investment of $100 million. The expected per annum income generated by project is estimated to be $25 million for next 7 years. The payback period of this project can be calculated by using the even payback period formula.

Payback Period = Initial Investment / Annual Cash Flow

Payback Period = $100M/ $25M

Payback Period = 4 Years

In above example, the project will recover its initial investment in first four years and the income generated in next three years will be considered as profit.

**Example 2:**Uneven Cash FlowsLet’s assume, Company A is taking a decision that involves undertaking a project that requires initial investment of $50 million and the expected income generated by project is $10 million for first year, $13 million for second year, $16 million for third year, $19 million for fourth year and $22 million for fifth year. The payback period of this project can be calculated with the help of uneven payback period formula as discussed above.

(cash flows in millions) Cumulative

Cash Flow

Year Cash Flow

0 (50) (50)

1 10 (40)

2 13 (27)

3 16 (11)

4 19 8

5 22 30

Payback Period

= 3 + (|-$11M| / $19M)

= 3 + ($11M / $19M)

≈ 3 + 0.58

≈ 3.58 years

It is really easy to calculate payback period for any project once you know about the initial investment and cash inflow values. Investors often use this method to determine whether it will be fruitful to invest their money in a particular project or not.