What simple payback tells you and leaves out

A simple payback period tells you when a project's accumulated net cash inflows first recover its initial outlay. It does not tell you the project's complete cash result. Payments and receipts after that point can still change what the project leaves behind.

The first recovery date

Consider an invented three-year project requiring a $6,000 setup payment at the start. Compared with not undertaking it, the model supplies $3,000 of additional net operating cash after the first year, $3,000 after the second and $2,000 after the third. These amounts are after all routine project operating payments.

Those net cash flows arrive at the stated year-ends, with none between them. The fictional agreement also requires a separate $5,000 removal payment at the end of year three, after that year's operating cash arrives. This is a before-tax model with no financing, resale receipt or other project cash flow.

OpenStax's payback explanation follows accumulated project cash flows until they recover the initial investment. On this schedule, the first $3,000 recovers half the $6,000. The next $3,000 reaches the full amount at the end of year two. The simple payback period is two years.

One invented project, including its later removal payment

Scroll across to see every column. Use the arrow keys when the table is focused.

The last column is the project's net cash result to that point, including setup. It excludes funding supplied by an owner and any withdrawals; it is not a bank balance.

Reaching zero does not end the project

At the end of year two, the project's operating cash has equaled its opening outlay. The remaining year still supplies $2,000 and requires $5,000. Across all three years, net operating cash totals $8,000, while setup and removal require $11,000. The complete modeled cash result is minus $3,000.

The two-year calculation is arithmetically correct. It is incomplete as a description of the undertaking. If the earlier receipts are being considered available for another use, the later commitment still needs funding.

OpenStax identifies post-payback cash flows as one limitation of the method. Simple payback also adds amounts without discounting for their different arrival dates. It is not a discounted return measure, a percentage return or the company's accounting profit. The profit-and-cash reading follows the separate accounting question.

The amounts and dates remain assumptions. A delayed receipt could move the recovery date or prevent recovery within the modeled period. Spreading annual amounts evenly across the year would invent earlier cash that this schedule does not supply.

Keep the date and change the ending

Try a separate variation. Keep the setup payment, the first two years and the $5,000 removal obligation unchanged. Replace the third year's net operating cash with $6,000. What happens to simple payback, and what happens to the full cash result?

Payback remains at the end of year two. The full result becomes positive $1,000: $3,000 plus $3,000 plus $6,000, less $6,000 of setup and $5,000 of removal. The same recovery date accompanies two different cash results.

When reading a payback claim, recover the cash schedule and keep going past the recovery date. Identify what is still owed, what is still expected and when the undertaking actually ends. Use the break-even and cash-forecast comparison for the different question of covering operating costs and funding payment dates. To start Infinite Upside: Building Wealth With Room to Live, read the opening.