In conditions of accumulation of sufficient quantity(one might even say the appearance of some surplus of capital that can not be used in one's own business), private individuals and financial institutions are thinking about making existing available free money work, because it is the self-expansion of capital that is its main function. In order to understand how quickly the entrepreneur will begin to make profit from the invested money, the payback period of investments is calculated. About what this indicator means and how it can be calculated, we'll cover in this article.
The payback period of investments shows in whichtime income from the investment itself will exceed the amount of investment and the project will start to make a net profit. Calculation of this indicator is important for an investor, because it gives him the opportunity to assess the riskiness of the project and the time during which he can not use the embedded resource.
Let's give a simple example.If the project invested a million dollars, and the annual income is one hundred thousand dollars, then the payback period of investments will be ten years. At first glance, it may seem that the faster the project pays off, the more willing it will be to invest money, but in fact it is not quite so, and below we will explain why.
Calculation of the payback period is the most importanta procedure that precedes the decision to participate or to refuse to participate in a particular project. Depending on the duration of the project, different approaches can be applied:
- If the projects are short-term (up to a year),calculates the normal payback period of investment - a private division of the invested amount for a monthly income. This procedure allows us to calculate when we receive our money in the so-called future value.
- In case the project is designed for several years,it is advisable to calculate the discounted payback period of investments, which allows us to estimate when we return the invested money in current value. The difference between the current and future value is that money is subject to the process of inflation, that is, depreciation. Thus, for a million dollars today you can buy more real values than for the same million dollars in ten years. In order to understand when we will return the invested amount in real value at the time of investing, the discounted payback period is calculated. Calculation of this indicator for short-term projects does not make sense, since in a more or less stable economy, inflation for the year is about 5-7 percent, and in the short term will change them at best for several weeks, which for big business is not a term, taken into account. The discounted period is conveniently calculated as follows: the simple period is multiplied by the sum of a unit and the average annual inflation rate raised to the power equal to the number of years of investment.
Along with the cash flow, the future and currentthe cost of money, the payback period is one of the most important indicators used in the work of the investment manager. It is worth noting that the faster payback is usually associated with greater risks - the higher the rate of return, the more dangerous moves have to be made in order to achieve it. Thus, not every investor pozaritsya to the rate of return at 300% per annum and the payback in four months - too likely that his investment will simply be burned as a result of unforeseen circumstances or carelessness of the manager. Investments with less profitability and a longer payback, on the contrary, inspire greater confidence.
