What is the payback period?
The investment payback period is the indicator that shows how much time it will take until the initial financial contribution is returned . Imagine that the founders of a startup want to know the time until the business starts to make a profit. They must use the PRI to make the calculation and draw a strategic plan from it.
The metric is also widely used to assess the return an entrepreneur will have when investing in a franchise, for example. An initial contribution of R$50 thousand reais to become a franchisee can become more attractive as soon as the investment return period is known.
It is a projection made from information from the business itself to understand more about the future scenario. It is, therefore, the calculation of the time needed to recover the investment that was made to take a business off paper .
For an e-commerce , the account must include from the amounts related to what was spent on marketing automation solutions and tools to the costs to host the virtual store and the contracts signed with suppliers.
This metric allows the manager , partner or entrepreneur to assess the prospects for that business. Furthermore, it can be an attraction for a company to be able to attract investors to help in its development. The return on investment period is also known as payback, and is widely used in the corporate environment.
Why is it important to calculate this deadline?
In practice, what are the benefits of understanding the payback period? Whether for a company or for a specific process, the calculation is very useful for those who want to have as much information as possible before making a decision.
Understanding the risks
You’ve probably used SWOT analysis to assess your business scenario, haven’t you? The matrix that helps to identify the threats, strengths, weaknesses and opportunities is essential to understand in which context a company, a product or even an idea is.
When calculating the payback period, you are understanding one of the risks (threats) or opportunities for that business. A startup with a very high deadline may have difficulties in attracting new investors, for example.
Meanwhile, a quick turnaround for a specific strategy or tool that helps a company boost its sales can make the value proposition even more attractive. This allows for a detailed analysis of the risk that that contribution may result, essential for an efficient administration .
Many people take a back seat to perform a calculation of certain metrics because of the complexity. The good news is that understanding what the payback period is is very simple to be done and with a high level of precision . Your team doesn’t need to spend hours doing a calculation, as an easy-to-apply formula already shows the result.
In the Big Data era , every company must collect as much information as possible about the functioning of its operations. It is from this constant analysis that it is easier to make the right decisions.
By calculating the payback period, you and your team can focus on the number and draw up a strategic plan based on the final result . Is the deadline too high? What are the necessary ways to reduce this time until the business or investment pays for itself?
Knowing that the time for the return will be long, how should your company organize itself financially to get through the moment without any kind of budget problem ? There are several insights that can be generated from this calculation.
Reduction of Incorrect Assumptions
Few things are as harmful to a business as guesswork. Can you imagine defining who your company’s persona is , simply because you think this is the ideal customer profile? Without doing any research or analysis?
Assumptions are very damaging, especially at a time when the hit rate needs to be high to stand out in such a competitive market . Before making a decision, you won’t “think” the term is X or Y. You’ll do a math to identify a period that actually makes sense.
Imagine how many mistakes can be made from a wrong assumption? A series of decisions that are harmful to your business can be triggered, which results in the loss of resources and, in more serious cases, even the closure of a company.
If you organized yourself thinking about having a return on investment in two years, but it happens in four years, there are many variables that need to change. If the budget has not been planned to wait that long, the whole business may not survive. The same goes for purchasing a solution that may have a result much later than what is needed for your company .
Calculating the payback period also helps your business find the solutions you need for the best results. It is not only necessary to make assumptions, your team can identify which are the points that need to be improved in order to achieve the objectives .
A longer time to achieve the financial return may imply operational changes. Let’s take an example: a team responsible for Digital Marketing of a company needs a CRM tool for better lead generation , but the deadline to get the return is very high.
The team can then devise parallel strategies that help accelerate that return. In this way, the tool will generate a positive impact as quickly as possible.
What are the points of attention when using this calculation?
In addition to the many benefits that payback time calculation offers, it’s important to be careful when using this metric.
The cash flow assessment is critical to making the calculation, but what if it’s wrong? What if the mistake is made even before using the formula? The result will be completely different, and it can mess up your planning.
Therefore, it is essential to use numbers closer to reality , always from a technical basis. For a franchise, for example, you can use the performance of other franchisees as a comparison to get a more accurate number.
In addition, it is necessary to take into account what problems may occur along the way. What if one of the tools purchased cannot be easily integrated into your company’s system? This could mean more time.
Additional cash flows
The equation does not calculate cash flows in previous years, to the point where the return is expected to be paid. It is possible that these cash flows are greater than in previous years.
The equation does not take into account profitability . As mentioned above, it is natural for companies and managers to look for businesses or solutions that have a shorter return on investment, right?
The idea is to have this return faster to be able to reinvest in other areas. But it is not always possible to understand what the profitability is based on this calculation.
The calculation does not consider what is happening in the rest of the company. Imagine that the purchased tool is working very well, but what about the rest of the operations?
The equation will be very specific and will not take into account other factors. This can end up masking other problems in your company’s internal processes and, thus, jeopardize the turnaround time.
In addition to what happens within an organization, there are external factors that influence the payback period. Attention: they cannot always be predicted. Who would have imagined a pandemic impacting retail companies, for example? The calculation does not consider these factors and can surprise and bring down the entire account.
without an ideal time
Another important issue that needs to be analyzed in relation to the calculated period is not presenting an ideal time to have this return. In other words, the calculation shows a value, but it is necessary to analyze a series of other factors to understand if, in fact, that period is the ideal one for your budget, or even to enable the business to have positive results.
How to calculate the payback period on an investment?
Now that you understand a little more about what the payback period is, how about putting it into practice? In addition to explaining how the calculation should be done, we separate other issues that need to be evaluated when doing the math. Check out!
What formula to use?
The formula used to calculate the payback period is very simple:
Initial investment / annual cash flow = period of return on investment (PRI)
Imagine that R$20,000 was invested to open your e-commerce, and the projection of the annual cash flow for the virtual store is R$5,000. Let’s do the simulation:
Initial investment / annual cash flow = period of return on investment (PRI)
R$20,000 / R$5,000 = Return on Investment (PRI)
PRI = 4 years
In other words, it takes four years until the e-commerce in the example has a return on investment. It is also essential to closely monitor what was stipulated.
Imagine that you have set the payback period to be two years. Over the months, it is necessary to monitor the evolution of the numbers to make sure that the amount needed to reach (or even anticipate) the time to have a return is within the initial planning.
The payback period is, therefore, an essential metric for those seeking to understand a little more about a company’s performance and its prospects for the future. With this calculation, an organization is able to identify problems along the way and act in a certain way so that everything that was initially planned is achieved.