Payback period
In one sentenceThe time a project or investment needs until the total cash flows it generates cover its initial cost.
Simply put
A simple question every owner asks: when do I get back what I paid? You add up the cash flows year after year until the total equals the start-up cost.
It is easy and clear, but it ignores what comes after payback and ignores the time value of money. Two projects with the same payback period may differ greatly in total profit.
Worked example
A car wash costs 240,000 SAR to set up, and it is expected to generate a net cash flow of 80,000 SAR every year.
Setup cost240,000 SAR
Annual cash flow80,000 SAR
Payback period = 240,000 ÷ 80,0003 years
Formula: Initial cost ÷ annual cash flow (when cash flows are equal)
Don't confuse it with
Net present valueNet present value counts all the years of the project and discounts them at a required return, while the payback period stops at the moment the cost is covered.