Business case training: What is payback?

Payback answers the question: How soon do I recover my cash investment?

You calculate payback as:

Stream of cash inflows divided by the original cash investment

So, if an investment produces a $100 a year for five years and the original investment is $300, then, the payback period is three years.

Payback is a useful, rough guide for assessing risk when doing any kind of IT due diligence. The longer the payback period the greater the risk.

It has limitations though:

  • Says nothing about the timing of cash flows (no discounting);
  • Ignores cash flows after the payback period;
  • Tells you when your investment principal is paid back, but is silent on the return on your capital.

Payback is, in summary, a solid supplement to an ROI analysis built around a net present value or discounted cash flow analysis.

For more ultra-concise, practical information on IT business cases and IT due diligence, please see the The Business Case Checklist.