As an investor, it becomes very important that you have a clear understanding in your mind of how long it will take to recover your initial investment. For this purpose, a payback period calculator becomes a necessity. It’s an online tool and you can use it to figure out how long it will take to recover the initial investment that you have made in a project or asset.
All this tool needs a few inputs to perform calculations and then shows you the time in which you can expect to receive your initial investment. If you don’t know how to calculate the payback period then don’t worry! We are going to show you the process so stay with us!
For Example,
If you invest $10,000 in a project and then you notice the project returns you $2,500 every year. This means you will receive 4 years to get your initial amount back. So, the payback period in this case would be 4 years.
Why Is the Payback Period Important?
Risk Management
- One famous saying is that the longer it takes to recover your investment, the more you can be exposed to potential losses. This means if an investment paybacks you in a shorter period of time, it’s considered a safe investment, and also it reduces the time in which your investment is at risk. So due to this reason, investors usually prefer projects with shorter periods because they feel safer and more secure.
Simplicity and Clarity
- The payback period is one of the easiest financial metrics to understand the outcomes. You don’t need to be a financial expert to calculate it. You can easily calculate the payback period with just basic information like how you have invested and how much you are getting back. This simplicity makes it a popular choice for investors who want to know a clear and quick assessment of an investment’s potential.
Liquidity Concerns
- Liquidity is all about how quickly you can access your money. If your investment has a long payback period, it means your money is tied up for a longer time. So it’s very important to know especially for the investors who want their money back sooner instead of later.
Comparing Investment Options
- If you want to invest in a project and you see multiple investment options, so in this situation a payback period calculator can help you compare them easily.
For Example,
If you are confused between two projects and facing difficulties to decide in which you should invest. One with a three-year payback period and the other offers you a shorter period of return. Then you can get help easily from the payback period calculator offered by calculator-online.net to compare both two opportunities.
Suppose the calculator gave you the result of 1st project which is five years and for 2nd project which is 3 years. So a wise investor always chooses the one who gives them a return in a shorter period.
How to Use a Payback Period Calculator?
Let’s go through a basic example:
- Input the Initial Investment: First, enter the amount of money that are going to invest. Let’s say $10,000.
- Enter the Annual Cash Inflows: This is the amount of money that you expect to receive back each year. Let’s assume $2,000 per year.
- Calculate: Hit the calculate button, and the calculator will show you the payback period. In our case, it would be 5 years.
Why a Shorter Payback Period Is Often Better?
Now you have a clear understanding of what the payback period is and how you can calculate it. Then a question might come into your mind which is why a shorter payback period is always preferable.
So here are a few reasons why it is:
Reduced Risk
As we have discussed earlier the sooner you get your investment back, there are less chance of your exposure to risk. It is also a fact that If something goes wrong with the investment after you have gotten back your initial money then you are less likely to suffer a big loss.
Greater Flexibility
The time you have recovered your investment after that you feel the freedom to reinvest that money elsewhere. This way you can take more advantage of new opportunities and also reduce your overall risk
Increased Confidence
A shorter period can also boost your confidence as an investor. You feel more comfortable when you get your money back quickly. As a result, you can take more risks and invest in different investments in the future.
When a Longer Payback Period Might Be Acceptable?
No doubt a shorter payback period is generally preferable but there are times when a longer payback period might be acceptable. For instance:
- High-Potential Investments: Sometimes an investment with a longer payback period may offer you higher returns in the long run. For example, when you invest in a new technology or a startup then it might take longer than usual to pay off. But the time when you receive the rewards it could be enough for you to make you satisfied.
- Stable and Predictable Investments If an investment is made in a stable industry with consistent returns then you should not worry about the longer payback periods.
