The payback on equipment is the amount of time it will take for a company to receive cash flows related to the equipment to pay back the original cost. This is an important measure for cost and managerial accountants as it helps the company plan its finances. It also shows if the company can afford to wait for the time of the calculation to have any return on the equipment. If it takes too long for a company to get a return on equipment, it may not undertake the project.
Determine the cost of the equipment. This is also known as the investment in the equipment. For example, a paper company adds another machine for $10,000 that will increase its annual production of paper by 10 percent each year.
Estimate the annual net cash flows the equipment should produce. In the example, the company calculates that the 10 percent increase in production will lead to an increase in annual net cash flows of $2,500 a year.
Divide the investment in the equipment by the annual net cash flows. In the example, $10,000 divided by $2,500 equals four years. Therefore, it should take four years of cash flows before the equipment pays for itself and the company starts making money on the equipment.