Payback Period Explained, With the Formula and How to Calculate It

payback period

Moreover, it helps to recognize which product or project is the most efficient to regain the investment at the earliest possible. But the fastest-growing SaaS companies on the planet owe between 20-40% of their revenue growth to “expansions revenue” — added revenue from upselling to existing customers. New SaaS businesses often underestimate the potential value of their existing customer base. It may seem counterintuitive to focus inward instead of bringing as many new customers into the business as possible. To break into these markets, connect with potential customers and ask them what additional features they’d like to see from your product (like two-factor authentication, user access controls, etc.). Then address those needs in a custom plan for enterprises at a much higher price point. Even if Facebook ads has the cheapest CAC at $277, it doesn’t matter if the average customer from Facebook only stays on for 3 months on a $50 per month plan.

payback period

However, if you are evaluating a future investment, it is a good idea to have a maximum payback period already set. How long are you willing to wait before the money is returned to you? We can apply the values to our variables and calculate the projected payback period for the new series. But, as we know, cash flow is not always even from period to period, especially when we are talking about the income from an investment. They’ve established a leadership position in a very specific market and built a network within that market.

Examples of payback period

It means that if you start a business to pay back your initial investment by ten years, it will take approximately 3.65 years using Equation 2 . Ineffective marketing can increase customer acquisition costs. You can identify where your ad dollars are better spent by breaking down the CAC by advertising channels. Figuring out the CAC payback period is a simple process, so it’s worthwhile for any business to know how to do it. First, you need to calculate the customer acquisition cost before the payback period can be determined. The CAC payback period is the time it takes for your company to recover the cost of acquiring a customer. Potential investors will be very interested in this fundamental metric as it provides an accurate view of a company’s growth potential.

The study of cash flow provides a general indication of solvency; generally, having adequate cash reserves is a positive sign of financial health for an individual or organization. To calculate the payback period, you need to know the initial investment amount, the net cash flow per period, and the number of periods before investment recovery. With these numbers, you can use the calculator above to estimate the payback period. IRR or internal rate of return is a financial metric used to determine the profitability of certain business investments. Most broadly speaking, the higher the IRR, the more desirable the investment opportunity is. IRR is calculated using the same formula as the net present value . Some acquisition costs are obvious, such as advertising and marketing spend.

Weaknesses of the Payback Method

The earlier the cash flows from a potential project can offset the initial investment, the greater the likelihood that the company or investor will proceed with pursuing the project. Payback term is minimal (6.50 years) for DASI and average (8.42 years) for FAMI. MI’s high energy yield leads to higher annual energy savings, but MI’s cost is 87.5% higher than SI, so DAMI and FAMI’s payback period is higher than DASI and FASI systems. The payback period method of evaluating investments has a number of flaws and is inferior to other methods. A major disadvantage is that after the payback period, all the cash flows are completely ignored. It also ignores the timing of the cash flows within the payback period. Payback period is a quick and easy way to assess investment opportunities and risk, but instead of a break-even analysis’s units, payback period is expressed in years.

  • I could also refer to the cells here, but be careful when you’re referring to these cells— this has a negative sign, so you need to add a negative sign to make sure the result is going to be positive.
  • The company can try increasing prices or introduce premium or enterprise tiers to see if it affects the payback period positively.
  • And it can be calculated from the beginning of the project or from the start of the production.
  • Here’s a hypothetical example to show how the payback period works.
  • Perhaps other machines need to be shut down for extended periods in order to allow this new machine to produce.
  • The payback period is not set in stone; you have the tools to change how long it takes to make a profit.

Second, it only considers the cash inflows until the investment cash outflows are recovered; cash inflows after the payback period are not part of the analysis. Both of these weaknesses require that managers use care when applying the payback method.

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