Payback Period for IT Investments
The length of time required to recover an initial investment through cash flows generated from the investment.
Example: A Human Resource software application that costs $150K and will generate $50K in annual savings in four years.
Initial Cost
|
$150,000
|
Year 1 Savings
|
$50,000
|
Year 2 Savings
|
$50,000
|
Year 3 Savings |
$50,000
|
Year 4 Savings
|
$50,000
|
Payback period = $150,000 / $50,000 = 3 years
Example: A Human Resources Application that costs $150,000 and has variable savings each year.
Initial Cost
|
$150,000
|
Remaining
|
Year 1 Savings
|
$60,000
|
$90,000
|
Year 2 Savings
|
$60,000
|
$30,000
|
Year 3 Savings |
$40,000
|
0 (+$10,000)
|
Year 4 Savings
|
$20,000
|
0 (+$30,000)
|
Payback period = 2.8 years
Payback period:
simple
widely used
easy to understand
provides managers with a way to communicate across the organization
provides some indication of the level of risk of a project by separating those projects that require a short vs. long time to recover the investment
a good initial screening tool to determine the profitability of software or technology investments
