Calculation of enterprise payback. Profitability and payback of the project: two factors for safe investment
The economic activity of any organization in market conditions requires the widespread attention of a large circle of business representatives who show interest in the results of its functioning.
A realistic assessment of their financial condition and the capabilities of potential competitors, to identify which it is necessary to conduct timely, qualitative analysis of all economic activities, identify shortcomings and eliminate them in a timely manner.
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What does this indicator mean?
The level of profitability shows how effectively the current costs of the enterprise are used. It is calculated as a percentage and expressed by the degree of profitability, that is, the amount of net profit.
To obtain net profit the enterprise must carry out expedient activities depending on the turnover of capital and the volume of products produced or sold. Profits are spent on development, ensuring scientific and technical equipment, increasing wages employees, formation of budget funds.
It is expressed by two indicators:
- Absolute. It is the amount of revenue that exceeds the costs of economic activity, production of products.
- Relative. Shows the level of profitability.
Net profitability is calculated for the whole enterprise or its separate divisions, by type of product. Analysis of its indicators allows us to obtain the dynamics of development, production efficiency, and sales of manufactured products.
Payback of various types with formulas
According to the instructions of the President of the Russian Federation, maximum profitability levels of 10 - 20% are applied to products for which free prices - tariffs - are established in accordance with current legislation.
For goods with established rental payments in the form of excise taxes, they are determined without taking them into account.
When increasing specific gravity production costs due to the use of purchased materials, semi-finished products and components exceeding 85 % it is set to size 15 percent.
Table 1. Current indicators
| No. | Name | Profitability level as a percentage of cost |
| 1 | Products of metallurgical, mechanical engineering, chemical, petrochemical, woodworking, pulp and paper, light industry | 25 |
| 2 | Products of mining enterprises of all industries and logging enterprises | 50 |
| 3 | Products of mining and metallurgical enterprises, non-ferrous metallurgy and mining and chemical enterprises | 40 |
| 4 | Construction Materials | 25 |
| 5 | Tobacco, tobacco products, egg products | 40 |
| 6 | Products from other industries | 25 |
| 7 | Transportation by all types of transport | 35 |
| 8 | Transportation of passengers by air and related work and services | 20 |
| 9 | Services of supply and marketing organizations and enterprises | 50 (to distribution costs) |
| 10 | Enterprises and wholesale trade organizations | 3 (to turnover) |
| 11 | Enterprises and retail organizations | 8 (to turnover) |
Costs
Payback is economic efficiency invested authorized capital. The payback period is calculated using the formula:
T=Vzat/D, Where
Vzat– volume of invested capital;
D– the average amount of income growth over the period of time under consideration.
It is used when choosing the best options for the implementation of enterprise activities related to technical and design solutions, production technology. For various options different capital investments and operating costs are required.
Cost return is calculated as:
P=Prp/S,
Where Prp– profit before tax;
WITH– the total cost of products that were sold.
A dynamics graph is constructed based on the indicator, showing the need to revise the cost of products and increase costs. The volume of trade turnover increases with increasing profitability; if the amount of costs remains unchanged, then profit increases accordingly and vice versa.
Activities
The return on costs in production activities is calculated as the ratio of net profit and depreciation over a certain period of time to the amount of expenses spent on selling products, which relates to operating costs.
Its formula:
R=(Pchp+Amor)/Z,
Where Pchp- net profit;
Amor- depreciation deductions;
Z– costs of production and sales of products.
In production activities, the organization's profitability ratio expresses the return on production costs, the amount of profit for each ruble spent on the production and sale of products.
Services
Providing services in any area does not require certain production costs.
In this situation, the “service” becomes the product sold, so its cost and profit depend on quantity.
It is necessary to formulate the cost of the service provided, taking into account the field of activity, calculate the projected demand, and find the gross income. Subtract variable and fixed costs from gross income.
The payback period for the service provided is calculated using the formula:
Tu=Zu/Pu,
Where Zu– costs invested in the business;
Pu– planned profit that will be received as a result of activities to provide services.
The effectiveness of services provided is calculated using the formula:
RSD=(Psd*Spvr)/Z*100%,
Where Z– costs associated with organizing services;
Spvr– number of services for a certain period of time;
Psd– profit from the sale of services.
Watch a video on the topic of profitability and profitability of an enterprise
Fixed assets
Instruments of labor that take part in the process of production while maintaining their original form are classified as fixed assets. This also includes tangible assets used in production or provision of services, which make up the difference between the cost of fixed assets and accumulated depreciation.
They ensure the activity of the enterprise for a long time, receiving physical wear and tear, which reduces them and transfers them to cost through depreciation.
The payback of fixed assets is determined by the formula:
T=Os/Pch,
Where OS– fixed assets of the enterprise, expressed in monetary form;
Pch– net profit for a certain period of time.
The effective use of fixed assets is determined by the formula:
Rosn=Pch/Os*100%,
Where OS– amount of fixed assets;
Pch– the amount of net profit.
Transactions
The profit from a transaction for the sale of products must be commensurate with the costs of its organization. In a simplified form, a condition is provided in which payback is equal to costs.
Payback includes the total profit from all transactions:
O=P*Co,
Where P– average profit from one transaction;
Co– number of transactions carried out.
If a company took out a loan from a bank to develop an enterprise, then the bank loan is taken into account in the calculations.
You can estimate the payback period for separate types of transactions using the formula:
Tokup=Z/(Sper*P),
Where Z– costs associated with organizing the transaction;
Sper– number of transactions over a certain period of time;
P– the average profit received as a result of the transaction.
Rsd=(Psd*Sper)/Z.
Personnel
Investments in labor must pay off and, in addition, bring profit. Payback is in direct proportion to the employee’s length of service at the employee’s given enterprise.
Personnel payback is calculated using the formula:
T=Zed/Fyear,
Where T- payback period;
Zed– one-time costs;
Fyear– annual economic effect.
To obtain the effect and increase the length of service, the company works on:
- expedient use of the working time fund, improving employee qualifications, increasing labor productivity;
- increasing the employee's stay at the enterprise. Extensive experience work leads to a quick payback.
Consequently, in a team with a stable environment, where working time is fully used, conditions are created for obtaining a return on funds and making a profit.
The profitability obtained from the use of personnel can be calculated using the formula:
R=Pch/Kp*100%,
Where Pch- net profit;
KP– average number of personnel on the list.
Net profit
The payback period can be traced using the example of a store that has been operating for some time. To determine the return on net profit, it is necessary to find the amount of gross revenue of the outlet for the period of time under consideration. Next, the amount of profit that the organization intends to receive in the course of its activities for the same period of time is determined.
Then the net profit is:
P=V*Stz
Where IN– gross proceeds from sales of goods;
Stz- current expenses.
The payback period is calculated using the formula:
Tokup=Ko/Pch
Where Co.– capital investments for the purchase of goods;
Pch– net income after taxes.
The profitability ratio from the sale of goods can be determined using the formula:
Rpr=Ppr/Vpr *100%,
Where Ppr– profit received as a result of sales of products;
Vpr– sales revenue.
Property
To determine payback, you need to make a list of assets that are on the balance sheet of the enterprise, indicating each of them. Then you should calculate the cost of depreciation individually.
The calculations contain the residual value of the property, calculated as the difference between the original cost and the amount of depreciation. Depreciation is calculated according to the instructions of the Unified Standards of Depreciation Objects, which is given in accounting.
To determine the payback period of property, the formula is used:
Tim=Sost/Pch,
Where Composition– the value of the enterprise’s property;
Pch– net profit for the period of time under consideration.
Effective use of property over a certain period of time determined using the formula:
Rome=Pch/Comp*100%,
Where Pch– net profit received as a result of the operation of the property;
Composition– the residual value of the property for a certain period of time.
General
The total payback period for funds invested in production is determined by the period of achieving the result, which acts as profit or a decrease in the cost of production.
The payback period is calculated in different ways depending on the volume of incoming Money and accounting for inflation.
The overall profitability is determined as follows:
P=V/P,
Where V– total volume of capital investments;
P– average annual revenues to the enterprise.
The total payback period is determined economic activity organization, its profitability, economic efficiency and feasibility of further development. Based on this assessment, improvement methods to be adopted for the reorganization are developed.
Methods for calculating profitability levels
By balance
The activities of any organization are based on the indicator of overall profitability, so most enterprises are obliged to ask the question: how to calculate profitability? It is the main parameter when conducting financial analysis.
Book profit margin is calculated using the formula:
R=Pb/F*100%,
Where Pb– the total amount of profit on the balance sheet;
F– average annual cost of fixed production assets, intangible assets and tangible working capital.
To establish how much an organization has developed over a certain period of time, in addition to the general one, it is necessary to find values that characterize the profitability of turnover and capital turnover.
In a market economy, the turnover indicator is most widely used: the higher the profit, the greater it is. The number of capital turnover is expressed by the ratio of gross revenue, that is, turnover, to the amount of its capital. An increase in the number of capital turnover leads to an increase in the organization's gross revenue.
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By EBITDA
To establish the capabilities of an enterprise and determine the value of a business, the EBITDA index is used, which means gross profit without deducting interest accrued on it, dividends, before taxes, and depreciation.
The initial data for calculating the indicator are high-quality and undistorted accounting data.
These figures are obtained from financial statements prepared in accordance with IFRS. Using the ratio, the operating results of the enterprise are assessed, which is closest to the operating cash flow.
The calculation of EBITDA reflects the profitability of the company's sales, funds forthcoming and earned during the reporting period. The calculation helps to evaluate the return on investment and self-financing reserves.
EBITDA is calculated using the formula:
E=P(U)dn+(%purchase+Aon),
Where P(U)dn– profit (loss) before taxation;
%purchase- Percentage to be paid;
And he– depreciation of fixed assets and intangible assets.
The calculation of the EBITDA profitability ratio is calculated as:
EBITDA margin = EDITDA / Sales revenue
EBITDA is earnings before interest, taxes and depreciation costs.
If there was a loss
If for last year the enterprise suffered a loss, then the profitability index does not need to be calculated, but the return on production can be calculated.
To do this, use the formula:
Oprod=B/Sprod
Where IN– revenue from product sales;
Sell– cost of products sold.
Ways to increase the indicator
The level of profitability of product sales is influenced by many factors. The main ones are:
- rising costs;
- decrease in product sales volumes.
To increase it in the first case, a thorough analysis of the costs included in the cost of production is carried out. Based on the data obtained, ways to increase profitability are modeled and possibilities for reduction are explored. Based on the audit performed, the following decisions should be made:
- based on the analysis, identify significant and growing expense items;
- reduce costs as much as possible without compromising production;
- clearly distinguish between fixed and variable costs in order to calculate the threshold of profitability, which corresponds to the volume of turnover without loss, but also without profit;
- conduct an analysis of the profitability of individual types of products, based on profit margins, examine the possibility of replacing the range of products;
- review marketing activities, improve product quality, develop a product sales plan using promotional activities.
When planning and starting your own business, the most important thing is to correctly calculate its profitability so that the money invested in it does not burn out. The development of your own business is influenced by many factors and parameters that need to be taken into account so that the business does not become unprofitable and fail. One of the important indicators is the payback of the business, its profitability, that is, the period during which the invested money will pay for itself and bring profit. The shorter the payback period, the higher the profitability of the business and enterprise.
One of the main problems of novice businessmen is the issue of payback for a new project. This is one of the main criteria when making a positive decision to create a business, in order to know how long the profit from doing business will be only the return on investment.
Two indicators are important here - absolute and relative. Absolute is the result that was obtained from investments and is measured by the increase in profit.
One way to calculate the payback period is non-discounted calculation method.
Let's look at an example to make it easier to understand the essence of the method. For example, to produce a product you buy equipment for a total amount of 100,000 rubles. To do this, you must calculate the cost of the goods produced, which includes the cost of raw materials, production costs, and depreciation of equipment. Let's assume that the cost of a unit of goods will be equal to 100 rubles, and that it is manufactured in one hour. This means that 8 goods will be produced per shift. Based on this, it is possible to calculate over what period of time it will be possible to return the funds that were invested in production. Payback period formula: Payback period = cost of production equipment / cost of goods for one month = 100,000/800 * 25 = 5 months.
But this is a very simple calculation; here you can see by what principle and order you need to calculate.
For a complex and serious project, it is necessary to take into account all the costs incurred in the production and sale of goods, the risks, which, ultimately, all together affect the return on investment.
For a person who wants to start his own business, he needs to correctly calculate the payback of the project and its profitability. You can do this yourself or by contacting a financial specialist.
It is necessary to take into account market factors, what is the demand for the product, at what stage there may be delays in the sale or production of the product. There is a lot of information now, both in books and various websites.
Rental business payback
The rental business is one of the simplest and most reliable investment options.
It is also important that the owner’s constant presence and involvement in the process itself is not required. If the premises and the tenant are chosen correctly, then renting it out can bring a constant and stable income. Moreover, such activities can be combined with other business.
At first glance, assessing the profitability and payback of a rental business should not be difficult; you need to compare rental income and cost to get the payback period, the main indicator of the rental business.
The standard payback period for commercial real estate is 9-10 years. A payback period of 7-8 years for commercial real estate with a tenant is already quite difficult to find.
At the same time, sellers, buyers and appraisers can calculate the payback period differently. The difference here will be what indicator will be considered income when calculating payback.
The seller typically takes the amount of the lease payments for the year and divides the sales price by that amount. If a premises with an area of 220 square meters is sold, which is rented out for 1000 rubles per square meter per month for 22 million rubles, then the calculation will be as follows. The income per month is 200 thousand rubles, and per year 2 million 400 thousand rubles, then the payback will be 20 million/2.4 million8.3 years. And when selling such real estate, this exact period will be indicated.
It also happens that a long-term lease agreement is concluded with the tenant, and every year there is an indexation of 7.5%. In this case, the rental amount is calculated for each year, taking into account indexation, everything is added up. That is, the payback period here will be shorter.
Calculation of buyers
Buyers approach the calculation a little differently; the emphasis is on cash income, so to speak, net income, minus all expenses.
Expenses include a tax of 6% of income, expenses for security, cleaning, rent or payment for some utilities. The larger and larger the object, the more costs associated with it fall on the owner.
With a premises of 200 square meters, it is possible that all costs associated with maintenance are borne by the tenant, and other costs are insignificant.
Also, if the buyer is an individual entrepreneur with a simplified tax system, then he will have a tax of 6%. And the calculation of profit and payback will take into account the tax amount of 144 thousand rubles. Net income for two years will be 2256 thousand rubles, and the payback will be 8.9 years. Therefore, by rounding the period to 9 years, the buyer will decide that this is a fairly long period; the difference with the stated 7 years is significant.
For more large objects rental business, for example shopping mall, whose area will be about 4,000 or 20,000 square meters, according to the buyer’s calculations, the payback period may be higher, reaching 12 years.
A property becomes more attractive if it has a good location, number of floors, good condition, prestige, adequate rental rate and price per square meter, and the absence of legal fraud.
But the main criterion is the payback, and if it is higher than the period for which the buyer is ready, then this object is not considered.
Calculation of suppliers
Appraisers, as a rule, conduct their market analysis based on rental rates for such premises, and, with some adjustments, determine what the market level of rental rates is for a given property. However, they do not take into account already concluded real estate lease agreements, and this does not affect the assessment.
Appraisers analyze advertisements from websites and thus determine the market rental rate. What is important here is the experience and professionalism of the appraiser, knowledge of important factors that affect the rental rate, so as not to make a mistake in the assessment.
And in the advertisements, the price of the property may not correspond to the market price, but may be overpriced, and because of this, it has not been given up for six months.
Appraisers, based on a comparative approach to valuation, focus not only on the income approach, but also on calculating the value of real estate and its square meter. The presence of a tenant and rental income are not taken into account here. And the final cost is determined as the average value between calculations of rental yield and cost per meter.
Here the averaging mechanism plays a role, and as a result, appraisers receive a value that is exactly between the figure of buyers and sellers.
Each participant in the transaction forms an assessment based on their goals.
The seller’s goal is to sell the property at a higher price and as quickly as possible, so he does not pay attention to expenses.
For the buyer, it is more important to recoup the investment with a good return, and the buyer takes into account the net income.
Appraisers, as a rule, are not interested in what will happen next to the object; the main thing is to prepare an assessment report for examination.
To assess the effectiveness of invested costs in the activities of any company or manufacturing enterprise use relative indicators. One of these is cost effectiveness. The coefficient can be calculated different ways. For general data use data accounting throughout the organization or individual divisions, departments or areas of work. Cost return can be calculated by different types products.
Profitability is a relative indicator showing the ratio of expenses and income received. Its value is influenced by internal and external factors. Internal factors include:
- Sales (or production) volume;
- Technical data and capabilities of production equipment;
- Number and output;
- Cost of purchased goods, materials for production;
- Final price for the product.
External factors influence the level of market prices of the products offered, demand in the market, the level of competition and the share of the analyzed enterprise in the market.
Enterprise costs are the totality of all expenses incurred by the company for the production and sale of products. When calculating the cost coefficient, the full, workshop or production cost is used.
The coefficient shows the share of income received from each ruble invested in the activities of the enterprise. Based on its value and dynamics, you can evaluate the efficiency of enterprise management, the level of costs and compare it with industry-wide data or standard values.
General formula
Krz = Pr/Z
Where Krz is the cost-benefit ratio
Pr – net profit
Z – enterprise costs.
In form No. 2, net profit corresponds to line 2400. Costs are taken from several values: cost of sales for No. 2120, selling expenses for No. 2210, administrative expenses for No. 2220, interest payable for No. 2330, other expenses for No. 2350. In essence, this is the profitability of the enterprise or the return on total expenses. This takes into account all possible expenses of the enterprise reflected in financial statements. To calculate it for a group of companies, a holding company or several interrelated companies, reports should be consolidated. Reflects the overall efficiency of the enterprise and its management.
Other formulas for calculating cost effectiveness
Payback on products sold is calculated using the following formula:
Krz = VP/S
VP – gross profit,
C – production cost.
According to form No. 2, gross profit corresponds to line 2100. Expenses are taken from the “cost of sales” indicator for No. 2120. In essence, this is the return on cost. This does not take into account other expenses of the enterprise: commercial, administrative and other expenses.
From it we can judge the level of markup on goods sold. To analyze the profitability of expenses for a certain group of goods, a similar formula is used. For the calculation there will be indicators for each group of goods: profit from sales and cost.
To calculate sales efficiency, use a similar formula, adding additional company costs:
Krz = PR/ (S+K+U)
Where Krz is the cost-benefit ratio,
Pr – profit from sales,
C – production cost,
K – commercial expenses,
U – administrative expenses.
In form No. 2, profit from sales corresponds to line 2200. Costs are taken from the “cost of sales” for No. 2120, commercial expenses for No. 2210, and administrative expenses for No. 2220.
In order to see the overall picture of the use of invested funds, you can use the following formula:
Krz = W/V
Where Krz is the cost-benefit ratio,
Z – costs,
B – revenue for products sold.
The numerator reflects the sum of all expenses at the enterprise: cost price, commercial, administrative expenses, other expenses. It is more appropriate to take the value of revenue from management accounting, which reflects future income for products shipped but not yet paid for. Accounting records reflect revenue received into the company's current account.
The ROCS indicator is also used for calculation
The ROCS indicator is also used for calculation. It characterizes the efficiency of cash flows and investments. It is calculated using the following formula:
ROCS = NDPpr/S
Where ROCS is the profitability ratio,
NPVpr – net cash inflow,
C – cost.
Net cash inflow consists of two values: net profit, reflected in form No. 2 under line number 2400, and depreciation. Depreciation is reflected in account 02 in accounting. It is also included in the cost price. In the calculation you can see the required amount. The cost indicator is reflected in line 2120 of Form No. 2 of the financial statements. This formula reflects the level of return on production and the level of investment in production and sales of products.
The share of net income in the cost of production or goods sold is determined through the following formula:
Krz = PE/S
Where Krz is the cost-benefit ratio,
PE – net profit,
C – cost.
The numerator reflects the amount of the company's net income, this is line 2400 in Form No. 2 of the financial statements. The cost price can be taken from the same form under line No. 2120.
With its help, you can trace the dynamics of net income received at a certain level of costs. You can also predict the expected level of net income of the company when increasing production or purchasing goods.
Standard values
There are no strict definitions of the norm for this indicator. Each enterprise can determine for itself the level of acceptable cost-effectiveness and reflect this in accounting policy. The corridor of these values is also determined by the enterprise.
Many financial organizations determine the standard value based on general industry values. As a rule, it should be in the corridor from 0.15 to 0.4. However, you should consider how it is calculated.
There are no strict definitions of profitability standards
The value of the indicator in dynamics
To analyze the activity of an enterprise and its current costs, the indicator is studied over time. To do this, compare annual, quarterly or even monthly data.
A decrease in value can be characterized in different ways:
- Increase in expenses (cost) and decrease in profit volumes;
- Forced price reduction to stimulate sales;
- Increase in cost components.
An increase in the indicator characterizes:
- Cost reduction;
- Increased profits and income;
- Acceleration of asset turnover;
- Increasing the efficiency of using working and fixed assets.
These characteristics take place at a relatively constant level of enterprise costs. The dynamics of the indicator reflect other changes in the management of the company and characterize its effectiveness.
Analysis of indicator dynamics
To identify factors influencing the level of profitability, factor analysis is used. It consists of several step-by-step formulas. How to calculate indicators for factor analysis, listed below:
- We calculate the values at the beginning and end of the analyzed period. For example, you can take indicators for the reporting year and the previous year.
- We calculate intermediate values to identify the influence of each individual factor. To do this, we replace one indicator in the formula at the beginning of the period with its value at the end of the period. The resulting value is compared with the previous one. The difference will be a factor in the influence of the replaced indicator on the level of cost profitability.
- Gradual replacement of all values in the formula with indicators of the reporting period. The result should be the value of the reporting period. This means that the calculation was carried out correctly.
Analysis of influencing factors will reveal weak or, conversely, strengths. With their help, it is possible to regulate the value and level of costs in the future period and adjust the sales and production policies of the organization. This will also allow you to plan indicators for future periods when drawing up budgets for next year. For planning, you should take the values of the last few periods.
Effective business management involves making a profit and fully covering the invested costs. The time period after which the entrepreneur will return the funds spent, taking into account income, is called the payback period.
Description
Payback period is a criterion that reflects the payback time of investments. Payback is the return on funds invested in a project that an investor will receive after a certain time. For example, to launch a new project you need to invest two million rubles. Income for the year will be one million rubles. This means that it will be possible to recoup the costs of implementing the project in two years.
Depending on the area of investment, the payback period can be considered from different perspectives:
- Investments. From the point of view of an investment project, this is a time period after which the investor will be able to cover the invested costs from the profits received. Otherwise, this period is called the payback ratio. It shows the prospects of a particular project.
The greatest interest is generated by those projects whose payback ratio is lower. This means that the invested funds will be returned to the owner faster and profits will be received in a shorter time. At the same time, quick payback is characterized by the ability to reinvest funds in a short period of time.
- Capital investments. In this case, the payback ratio helps to assess the feasibility of investing in improving equipment or production. It reflects the period after which savings or income will be equal to the amount of money spent.
- Equipment. The payback period shows when the profit received from the equipment becomes equal to the funds invested in its purchase.
Calculation of the indicator
The payback period is calculated in the following sequence:
- The cash flow for the project is calculated taking into account discounting and determining the period for receiving income.
- The amount of financial flow is determined. This is the sum of expenses for a specific period of time and the receipt of profit from investments.
- A discounted cash flow calculation is made before the first profit is received.
- The payback period is calculated.
During the calculations, the value of the period for which investment investments will be blocked is obtained. Profits will begin to flow when the payback period ends. When it comes to choice, they prefer projects with a shorter period. This allows you to recoup your investment faster.
It is advisable to calculate the payback rate for investments that are carried out using borrowed long-term funds. In this case, it is worth considering that the calculation period should differ from the loan term to a lesser extent.
Calculation methods
The payback period can be calculated in two main ways:
method. Calculates time to cover initial costs.
He is the very first in financial practice. However, it allows you to obtain data only if certain features are taken into account:
- the analysis requires projects that have the same lifespan;
- financial costs are expected to be incurred once at the start of the project;
- it will be possible to receive income from investments in equal parts.
In a simple calculation, you need to focus on the value of the payback indicator. The higher the ratio, the greater the risk associated with investing. If the figure is less, then investing in the project is profitable and the funds will be returned in installments in a short period of time. The method remains relevant due to the simplicity and transparency of the calculation. When there is no need to deeply study the issue of investment risk, this method can be used.
The disadvantage of a simple calculation is the inability to take into account:
- constant change in the value of cash costs;
- profitability from financial activities, which will begin to arrive when the payback point is passed.
Dynamic (discounted) calculation. This calculation method is used more often because it is more complex and accurate. The discounted factor involves taking into account the changing value of money. In other words, you need to take into account the dependence of financial resources on changes in interest rates. Therefore, this coefficient will be higher compared to a simple calculation. From constancy cash flow the convenience of the method will depend. If financial receipts are different in size, then it is advisable to use graphs and tables to solve the problem of payback.
In some cases, the payback period is calculated taking into account the price of the assets upon their liquidation. When it comes to investment activities, assets are formed for their further sale and thus withdrawal of funds. During the liquidation process, the payback process for the project is faster. But do not forget that the liquidation price may increase during the creation of the asset, and also decrease due to wear and tear.
Simple method
Payback period formula in a simple way looks like that:
PP = K0 / PChsg,
Where RR- number of years of payback (the abbreviation PP is derived from the English expression “Payback Period”);
TO- amount of investment;
IF sg - average net profit for the year.
After applying the formula, it turns out that the project costs will be covered in 3 years. But such a decision is very approximate and does not take into account that during the project implementation period, for example, additional investments may be required.
In addition, we can highlight another simple calculation formula. But it is accurate if the profit flow comes in equal parts. The formula looks like this:
PP = IC / P + Pstr, where
IC– the amount of funds at the start of the project;
P– the average flow of funds that can be expected to be received;
Pstr– time from project launch to reaching maximum capacity.
Discounted
The discounted calculation method is more complicated because the value of funds changes over time. Therefore, the calculation is based on the value of the discount rate. Formulas used:
Where DDP— discounted (dynamic) payback period;
r- discount rate;
Lº– initial investment;
CF– cash receipts in period t;
n- payback period.
This will allow you to clearly see this method.
It is required to invest 170 thousand rubles in the project. Taking into account the average 10%, the real profit for each year is calculated using a table.
| Period of time | Estimated income, rub. | Calculation | Real income taking into account discount, rub. |
|---|---|---|---|
| 1 year | 30 000 | 30 000 / (1+0,1) 1 | 27 272,72 |
| 2 year | 50 000 | 50 000 / (1+0,1) 2 | 41 322,31 |
| 3 year | 40 000 | 40 000 / (1+0,1) 3 | 30 052,39 |
| 4 year | 60 000 | 60 000 / (1+0,1) 4 | 40 980,80 |
| 5 year | 60 000 | 60 000 / (1+0,1) 5 | 37 255,27 |
It turns out that the total profit for 4 years is only 139,628.22 rubles. That is, even during this period of time the project will not pay for itself, because 170 thousand rubles were invested. But over 5 years the amount of profit will be 176,883.49 rubles. This figure is already greater than the initial investment. Then the project will pay for itself between the 4th and 5th year of its existence.
The discounted calculation method shows the real level of investment income that should be targeted.
Exists general formula payback period of investment costs:
Where PP- payback period;
n– number of time intervals;
CFt– receipt of funds in time period t;
Io– the amount of initial investments in period 0.
The formula reflects when sufficient returns will be provided to cover the investment. This calculation characterizes the degree of financial risk. The start of a project is sometimes characterized by a loss of funds, so in practical calculations the amount of outflow of investments is put in place of the Io indicator.
As an example, consider the following situation. Funds were invested in the amount of 120,000 rubles. Profitability by year was distributed as follows:
- 35,000 rubles
- 40,000 rubles
- 42500 rubles
- 4200 rubles.
Profit for the first three years will be 35,000 + 40,000 + 42,500 = 117,500 rubles. This amount is less than the initial costs of 120,000 rubles. Then it is necessary to estimate the profit for four years: 117,500 + 4,200 = 121,700 rubles. This figure is already more than what was initially invested. This means that the project will pay for itself in 4 years.
To accurately calculate the period, it is necessary to assume that income comes in equal amounts over the entire period of the project. Then the remainder is calculated as:
(1 - (121700 - 120000) /4200) = 0.6 years.
Thus, it turns out that after 3.06 years this investment project will completely pay for itself.
Pros and cons of the indicator
Like any financial indicator, the payback period has its advantages and disadvantages. The first include:
- simple calculation logic;
- clarity of assessment of the period after which the invested funds will be returned.
Among the disadvantages are:
- The calculation does not take into account the income that was received at the moment when the payback point was passed. When analyzing alternative projects, the risk of making mistakes in calculations increases.
- To evaluate an investment portfolio, it is not enough to focus only on the payback period. More complex calculations will be needed.
When it comes to investments, payback and its time period is one of the important indicators. Entrepreneurs should focus on it in order to make the right decision and choose a profitable investment option.
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To determine the attractiveness of investment programs and capital investments, a universal indicator is used - payback. We will explain what payback is below.
Before investing in a new or existing business project, any investor evaluates his own risks, the time interval for the return of invested funds, and the prospects for making a profit.
Return on investment is the level of return of invested funds to their owner after a certain period.
Cost recovery is the ratio of the income received from the project to the costs incurred.
The payback point is the moment at which the invested funds are fully covered by the income received. After this, using a coefficient or percentage or interest rate return on capital invested (expenses incurred).
If an enterprise makes capital investments to reconstruct an existing facility, the effectiveness of long-term costs is calculated.
Payback period and how to determine it
The time interval during which the invested costs are returned by the income received is determined by simplified statistical methods, or taking into account discounted cash flow.
A simple arithmetic calculation of the return period of invested capital is determined as the amount of income received (cash) compared to the investments made in a business project.
The second method is economically more accurate and correct. Over time, financial resources are subject to inflationary processes, so it makes sense to take into account the discount rate prevailing in the region or a specific sector of the economy.
For shareholders simple methods determining the effectiveness of the acquisition of shares is to use indicators of net profit per 1 share, or accrued dividends per 1 share.
Calculation formulas
To simplify the calculation of the effectiveness of investments, the formula is used:
Payback period = investment / average annual profit
To calculate the payback period taking into account inflation expectations and applying a discount, complex formulas are used, for example:
Payback period with discount = P – (S DCFt / DCF+1),
- where P is the quantity full years project, after which the payback point occurs
- S DCFt – total accumulated balance of financial flows (including discount) up to the year of the payback point
- DCF+1 – discounted financial flow in the period of reaching the payback point
Calculation examples
Example 1. An investment was made in Ecoprom OJSC to produce food products using new technologies. Costs for new project amount to 2 million rubles. It is planned to receive net profit from the project: 
- 1 year – 50 thousand rubles.
- 2nd year – 250 thousand rubles.
- 3rd year – 500 thousand rubles.
- 4, 5 years – 750 thousand rubles.
Over 5 years, the planned amount will be 2,300 thousand rubles or 460 thousand rubles/year. Payback period = 2000 / 460 = 4.3 years.
Example 2. The initial data for the business project of OJSC Ecoprom are presented in Table 1 (thousand rubles).
Indicator/year | ||||||
CF - financial flow | 2000 | |||||
2000 | 1950 | 1700 | 1200 | |||
DCF (including 5% discount) | 2000 | |||||
DCF cumulative | 2000 | 1952 | 1725 | 1293 |
* calculation of the discounted amount – 100 / 105 x 50 = 47.6. Round up to 48.
Thus, taking into account inflation expectations, the payback period for the new line of business of the joint-stock company exceeds 5 years. For example, if in the sixth year of activity it is planned to receive a net profit of 800 thousand rubles, then the total discounted payback period is 5 - (-88 / 800) = 5.11 years.
In addition to the discount, for a realistic calculation of the repayment period, one should take into account the general economic situation in the region and the investment industry.
Assessing these factors will help determine the likelihood of the need for additional investments throughout the project, unforeseen expenses, interruptions in sales and logistics processes.
Determination of cost recovery
Cost effectiveness is usually calculated in cases where annual additional operating costs are required in addition to the initial capital investment. They are also calculated by two methods: simplified and discounted.
Example 3. A thorough analysis of the Ekoprom OJSC project revealed that in the process of its implementation, the investor’s current costs in the amount of 100 thousand rubles are additionally required annually. These changes will affect the net profit and cash flows of the project.
Table 2. (thousand rubles).
Indicator/year | ||||||
CF - financial flow of investment/profit | 2000 | |||||
CF cumulative for easy calculation | 2000 | 2040 | 1870 | 1420 |
The table shows that the investor’s costs, even according to a simplified calculation, will pay off only in the 6th year after the implementation of the business project.
For a potential investor or owners of an existing enterprise, what matters is the level of profitability of the business after reaching the “zero mark” of return on funds.
For example, if in 6-10 years of activity a business entity reaches high level profitability (over 25%), its participants will consider investments profitable and are ready for further financing of activities. The planned estimate should include calculations of the return on invested capital for a long period (8-12 years).
To calculate the profitability of an investment, the formula is often used:
R inv. = (Revenue.inv – costs.inv) / 100%
The calculation takes into account investments, income and expenses (including taxes, mandatory payments) related to the business object.
If a long-term bank loan is used in whole or in part for investment, experts from the creditor bank Special attention additionally pay attention to the borrower’s solvency at the target dates of loan repayment, interest for its use using calculated debt coverage ratios.
What to consider when purchasing a business?
In the modern business world, a huge number of prepared economic activity projects are offered to potential investors:
- Existing enterprises are put up for sale
- Offered
- Buy (rent) prepared premises, equipment, technologies
Usually, when selling a business, it is presented “in a rosy light” and told about the rosy prospects for the development of the proposed industry. Payback period for sellers business rarely goes beyond 3 years, they promise high profitability.
Buyer's payback period when calculating, it may turn out to be many times more if he carefully studies the proposed business plan, analyzes the situation on a specific product market in a given industry and region, gets acquainted with suppliers of raw materials, materials necessary for the production of products, and its main potential customers. Along with an accurate assessment of the payback period of the proposed business, it is useful for the investor to consult experts about the future possibilities of its sale in the coming years.
When calculating payback, it is necessary to take into account not only the initial investment, but also the additional costs required in subsequent periods of the project. Its profitability may be affected by changes in exchange rates, the cost of basic elements of expenses (for example, fuel, electricity, metal), changes in types, tax rates, and other economic risks. The more accurately the calculations in the business plan are carried out, the higher the likelihood that the project will pay off within the planned time frame.
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