Payback accounting is all about evaluating the payback period, because it is a best practice. The most common definition of the payback period is that it is the period of time required for the repayment of the amount that was invested in an asset. The amount is repaid from the net cash outflow, and this is the amount from the initial or capital investment. The payback period is expressed in years to assist in best practices with all kinds of businesses.
Let us assume that a company invests $600,000 in a new project. The project produces $100,000 every year as cash flow through best practices. This means that the payback period is six years. The formula used is:
Payback Period = First Investment = $600,000 = 6 years
Annual Payback $100,000
The advantages of calculating the payback period are all about risk assessment and risk management best practices. This provides a quick idea about the period of time the initial investment will risk ensuring compliance with best practices. Most business people tend to evaluate the risk involved with any investment based on the payback period. They hold on to the best practices of not investing in those assets that have longer payback periods.
However, this is more useful for those businesses where investments turn obsolete too soon. Similarly, payback accounting works best for those businesses where the return of the initial or capital investment is a major problem.
By using the payback accounting formula, one succeeds in best practices. It assists business people estimate the payback period, but there are some setbacks.
Nonetheless, using the payback accounting formula is an ideal best practice for both small and large business. It also helps with capital budgeting to promote best practices.