what is the payback period 
the payback period is the amount of time it takes to recover the cost of an investment simply put it is the length of time an investment reaches a breakeven point people and corporations mainly invest their money to get paid back which is why the payback period is so important in essence the shorter the payback an investment has the more attractive it becomes determining the payback period is useful for anyone and can be done by dividing the initial investment by the average cash flows investopedia tara anandunderstanding the payback periodthe payback period is a method commonly used by investors financial professionals and corporations to calculate investment returns it helps determine how long it takes to recover the initial costs associated with an investment this metric is useful before making any decisions especially when an investor needs to make a snap judgment about an investment venture you can figure out the payback period by using the following formula payback period cost of investment average annual cash flow begin aligned text payback period frac text cost of investment text average annual cash flow end aligned payback period average annual cash flowcost of investment the shorter the payback the more desirable the investment conversely the longer the payback the less desirable it becomes for example if solar panels cost 5 000 to install and the savings are 100 each month it would take 4 2 years to reach the payback period in most cases this is a pretty good payback period as experts say it can take as much as 7 to 10 years for residential homeowners in the united states to break even on their investment 1capital budgeting is a key activity in corporate finance one of the most important concepts every corporate financial analyst must learn is how to value different investments or operational projects to determine the most profitable project or investment to undertake one way corporate financial analysts do this is with the payback period although calculating the payback period is useful in financial and capital budgeting this metric has applications in other industries it can be used by homeowners and businesses to calculate the return on energy efficient technologies such as solar panels and insulation including maintenance and upgrades average cash flows represent the money going into and out of the investment inflows are any items that go into the investment such as deposits dividends or earnings cash outflows include any fees or charges that are subtracted from the balance payback period and capital budgetingthere is one problem with the payback period calculation unlike other methods of capital budgeting the payback period ignores the time value of money tvm this is the idea that money is worth more today than the same amount in the future because of the earning potential of the present money most capital budgeting formulas such as net present value npv internal rate of return irr and discounted cash flow consider the tvm so if you pay an investor tomorrow it must include an opportunity cost the tvm is a concept that assigns a value to this opportunity cost the payback period disregards the time value of money and is determined by counting the number of years it takes to recover the funds invested for example if it takes five years to recover the cost of an investment the payback period is five years this period does not account for what happens after payback occurs therefore it ignores an investment s overall profitability many managers and investors thus prefer to use npv as a tool for making investment decisions the npv is the difference between the present value of cash coming in and the current value of cash going out over a period of time some analysts favor the payback method for its simplicity others like to use it as an additional point of reference in a capital budgeting decision framework example of payback periodhere s a hypothetical example to show how the payback period works assume company a invests 1 million in a project that is expected to save the company 250 000 each year if we divide 1 million by 250 000 we arrive at a payback period of four years for this investment consider another project that costs 200 000 with no associated cash savings that will make the company an incremental 100 000 each year for the next 20 years at 2 million clearly the second project can make the company twice as much money but how long will it take to pay the investment back the answer is found by dividing 200 000 by 100 000 which is two years the second project will take less time to pay back and the company s earnings potential is greater based solely on the payback period method the second project is a better investment if the company wants to prioritize recapturing its capital investment as quickly as possible 