Capital Budgeting: The Payback Technique

Budgeting is an important aspect of financial planning of a business. With the help of capital budgeting techniques a business decides the allocation, funding and the management of capital for long term projects, short term projects and other operations within the business. There are a number of budgeting techniques and one of them is the payback technique.

The payback technique of budgeting and planning is focused to measure the particular time span that is required by a firm to recover its initial investment in the form of cash. It is the time period taken by a project to earn the cash that equals the amount of expense a company made on that project. The payback period can be calculated by dividing the total investment made on the project by the net cash flow that occurs in the company per annum.

Payback Period in Cash = Capital Investment/ Annual Cash Flow

For example a company has a capital investment of $150,000 and the net cash flow within the company is $50,000. The payback period can be calculated as under:-

Payback Period = 150,000/50,000 = 3

So the Payback period is 3 years that means it will take three years for this project to recover the capital investment and to return that investment to the company. It is desirable for a company to have a short payback period as shorter the payback period the sooner it will recover its investment and starts paying the company in return.

Other Related Accounting Articles:

• Capital Budgeting: Internal Rate of Return
• Budgeting Methods: How to choose one for your business
• Zero Based Budgeting
• Fixed Budget
• Inventory Purchases Budget for a Merchandising Firm
• International Aspects of Budgeting
• Material Budgeting | Direct Materials Budget
• Zero Based Budgeting (ZBB):
• Selling and Administrative Expense Budget
• Profit Planning