Payback Period Calculator

What this calculator tells you

The payback period is the time it takes for an investment to return its original cost from the cash it generates. A solar panel that saves 4,000 a year on electricity bills, for example, pays back a cost of 20,000 in five years. It is one of the simplest measures of how quickly money comes back.

It is easy to understand and useful for comparing projects with similar lives, but it ignores what happens after the payback point, and it does not account for the time value of money unless adjusted. This calculator gives the simple version based on a steady annual cash flow.

How the payback period is worked out

For a steady annual cash flow, the payback period equals the cost of the investment divided by the annual cash it returns. The result is in years and can be a fraction of a year. Where the cash flow varies from year to year, the payback is reached when the running total of cash equals the cost, which requires a year-by-year count.

A worked example

Suppose an upgrade costs 20,000 and saves 4,000 a year in running costs. The payback period is 20,000 divided by 4,000, which is five years. If the saving were 5,000 a year, the payback would be four years. Each year after payback, the savings are pure gain for the life of the equipment, which the simple measure does not show.

Limits of the measure

The payback period ignores the cash that arrives after the payback point, so a project that pays back in four years but then stops could look better than one that pays back in five years and generates income for twenty. It also ignores the time value of money, because it treats money received in year five as equal to money received today.

Discounted payback corrects the second issue by discounting each cash flow at a chosen rate before summing them. Use it when the time value of money is important, such as for large or long-lived projects.

What the calculator leaves out

Maintenance, replacement, tax, financing costs and changes in energy prices or demand are not included. Savings are assumed to be steady and certain, which is rarely true for investments that depend on prices or usage. Check the cash flows after all costs and tax before relying on the payback figure.

Choosing between projects

When two investments have similar payback periods, look at what happens after payback. A project that keeps producing cash for many years may be worth more than one that pays back slightly faster and then stops. Use a longer-term measure, such as net present value, to make the choice.

Using the result

Use the payback period to screen investments quickly, rejecting those that take longer than you can wait to recover your cost. Then examine the shortlisted options with a method that includes the full life of the investment, such as net present value or the IRR.

Adding a margin of safety

Because the payback period assumes the cash flows arrive as expected, add a margin of safety before relying on it. Test a lower annual saving or a higher cost, and check how long payback would take under each case. An investment that pays back in four years when the figures are right, and in seven years under a plausible downside, carries more risk than the headline figure suggests.