Financial Payback

Financial Payback is a way to assess whether it is sensible to make an investment for future costs savings or extra revenue and contribution.

It is the number of months it takes to recover the money that has to be spent first.

Calculating The Financial Payback

For example, a business may have a two year old lorry which is fuel inefficient. Recent technology savings make new lorries much more economical to operate.

If it will cost £20,000 extra cash to trade in the existing lorry and buy a new one, but it will save £1,200 per month in fuel costs, how quickly will the business recoup the money.

To calculate it is simply the cost of the net investment divided by the monthly cost saving.

In this example that is 20,000/1,200 = 16.67 months.

Using The Financial Payback

Big groups usually have a rule to assess this kind of investment.

For example several groups I’ve worked with looked for a payback within three years. Each would have been delighted with the 16.67 months above and given a positive decision to go ahead.

It may not be so obvious for smaller businesses who have a limited amount of money to spend.

Buying the lorry may stop them buying something else which generates more cash.

If you are considering two investments for £20,000 and one pays back in 16 months and the other in 7 months, the second would seem the obvious option to take first. It means you’ve got your investment back and you’re ready to go again in month 8.

It gets a bit more difficult if the two investments are for different values and there are other much more complicated investment appraisal methods which involve trying to calculate the net present value of the cash flows. That approach looks at the investment over its entire life

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