What is a payback period?

Payback period in capital budgeting refers to the time required to recoup the funds expended in an investment, or to reach the break-even point. [1]

For example, a $1000 investment made at the start of year 1 which returned $500 at the end of year 1 and year 2 respectively would have a two-year payback period. Payback period is usually expressed in years. Starting from investment year by calculating Net Cash Flow for each year:

Net Cash Flow Year 1
=
Cash Inflow Year 1
−
Cash Outflow Year 1
{\displaystyle {\text{Net Cash Flow Year 1}}={\text{Cash Inflow Year 1}}-{\text{Cash Outflow Year 1}}}

Then:

Cumulative Cash Flow
=
(
Net Cash Flow Year 1
+
Net Cash Flow Year 2
+
…
+
Net Cash Flow Year n
)
{\displaystyle {\text{Cumulative Cash Flow}}=({\text{Net Cash Flow Year 1}}+{\text{Net Cash Flow Year 2}}+\ldots +{\text{Net Cash Flow Year n}})}

Accumulate by year until Cumulative Cash Flow is a positive number: that year is the payback year.