Making Financial Decisions Based on Payback

I’ve been looking at making some investments recently, looking into whether to buy money making websites and businesses so that I have a little extra money to work on my own projects. The problem I find with myself is that I find it hard to spend the money, as I haven’t got all of the information on whether I will make money back off the investment. It’s a risk, a risk which I want to take, but just don’t know whether I can go through with it. Luckily I have been researching and thinking about each of the investments to see if they are worth it.

In this article I want to present one of the methods I have been using to work out whether I will be investing or not; Payback. It’s all in the name really. Payback is the length of time that it takes for an investment to pay for itself. I’ve got two websites which I’m interested in purchasing and because of this I will use these two websites to show you how to use Payback and how it will help make a decision.

Working out Payback

To work out Payback we much divide the cost of the investment by the amount of money the investment will make in a certain amount of time. In these examples we will be using months, but it is very easy to use years, days etc.

Investment One – Costs $750 – Makes $300

This one seems the most interesting to me, due to its great earnings each month which would quickly make back the money which I invested. However, the current price is $750, but as it’s on an auction it could raise to anything, I’m thinking about $2000 at this point due to the money it is making each month. I will be using both of these figures to work out Payback.

Example One – Costs $750 – Makes $300

$750 / $300 = 2.5 Months

Example Two – Costs $2000 – Makes $300

$2000 / $300 = 6.7 Months

Investment One Decision

The costs are high at the start of the investment and I don’t really know if I want to spend that much, but from looking at the Payback it gives me a lot more confidence that my investment would pay me back quite quickly. I think if the price is about $1000 – $1500 then I would go for this investment.

Investment Two – Costs $300 – Makes $20

Obviously this one doesn’t look that great at the start because it is only making $20 a month, which is very low. However, I’ve taken into account my gut feeling on this one, because I think that I could get the earning a month up to at least $50 a month and hopefully something closer to $100 a month, which would mean the payback time would be just 3 months. As well as this, I think this website has a lot more room for growth, so I could constantly get more money each month, when Investment One is quite stale due to no room for growth. What I’m trying to put across here is that figures don’t mean everything; you have to take into account your own hunches as this will give you two perspectives of the investment. Anyway, formula time;

Example One – Costs $300 – Makes $20

$300 / $20 = 15 Months

Example Two – Costs $300 – Makes $50

$300 / $50 = 6 Months

Example Three– Costs $300 – Makes $100

$300 / $100 = 3 Months

Investment Two Decision

This one is a lot more risky, due to the price being quite high already and the earnings being quite low, meaning the initial payback is a massive 15 months. However, as you can see, a small increase in the money made will change the payback quite a lot and I think this is quite possible with this investment because it is based in a growing market.

What is Payback Doing?

Payback is giving us a way to be more confident in our investments because it shows us how long it will take to make the money back we have invested, which will help you see if you want to spend that much time on getting money back. The main problem with payback is that is doesn’t take into account the future earnings of the investment. For example, it could take 15 months to get your money back, but after that, it could be making you $1000 a month. Another problem is that the money you make can change a lot during the payback time, meaning if you want accuracy, you will have to constantly update the payback calculation.
Payback can help build confidence in an investment, or show you that its not worth it and as shown in this post, it is very easy to work out, so there is no point not doing it really.