How to Calculate Payback Period

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 Many scaling businesses fail because they don’t put enough emphasis on the Payback Period (which we’ll get to soon).

Your Payback Period (PBP) is the length of time it takes to recover the cost of an investment.

A Quick Guide to Payback Period

Your customer payback period (PBP) tells you how long it takes for a customer to be earning you profit. In other words it’s your payback velocity.

customer payback period chart demonstrating why it's important to calculate payback period as well as CAC

Why do we care about payback period?

Often used by marketers in conjunction with customer acquisition cost (CAC), a good payback period suggests profitable growth.

Payback Period is used to evaluate risk and/or liquidity of an investment. Your payback period calculates the time it takes for an investment to generate enough cash flow to recover its initial cost. In other words, it measures the period of time it takes for you to break even (another useful KPI).

Typically, this metric is expressed in years or months depending on your risk tolerance and the size of the cash investment.

“A faster PBP means more profit cycles in a shorter time period (and less capital needed to fund growth).”

Generally, you are aiming for a shorter payback period as it means you’ve recovered your investment sooner and lowered your risk exposure.

a cycle and bar graph showing how working capital and your equity benefit from a faster payback period

Cloud CFO Benchmarks: If you don’t have the capital to fund losses, your PBP should be short. A good payback period for a B2B company and SaaS companies in general is 12 months or less. But, it’s ideal to be less than six months if you’re in hyper-growth mode (greater than 50% revenue growth per year). For a B2C company we’d recommend to aim for an even faster PBP: say three to six months.

How to calculate payback period

To calculate payback period use the formula: payback period = Investment or cost of asset/(monthly revenue x gross profit %). So to calculate payback period per customer you would use this formula below:

calculate payback period using the formula: PBP = CAC/(Monthly revenue x gross profit %)

3 steps to calculate your customer payback period:

1). Find your customer acquisition cost

First, calculate your CAC using this formula: Customer Acquisition Cost = (Total marketing expenses + total sales expenses)/# of new customers acquired

CAC formula: CAC = (total marketing expenses + total sales expenses)/# of new customers acquired

Remember, your CAC includes more than the cost of ads.

While paid advertising may be obvious, it’s important to remember not to omit things like PR, Free Trial support and hosting, etc.

Included in CAC

  • Paid advertising
  • PR
  • Sales people base & commission
  • Sales manager compensation
  • Free trial and freemium user support and hosting
  • Affiliate fees
  • Cost to create content for SEO/social media strategy

Not included in CAC

  • Account management
  • Hosting
  • Training on new releases
  • Customer service

While many marketers and business owners focus heavily on how to lower customer acquisition cost (CAC), this can be misleading. For example, ABC Office Supplies has a $100 CAC and OfficePlus has a $500 CAC for a similar product. You’d think ABC Office Supplies is going to come out on top right?

Nope.

ABC Office Supplies takes 2 years to recoup that $100, while OfficePlus gets their $500 paid back in just three months with an additional $750 in revenue.

That’s why we recommend taking into account a few of the customer success KPIs like CAC:LTV and Payback Period to really focus on revenue growth.

2). Find your monthly revenue

Next up, to calculate payback period you’ll need to find your total monthly revenue: found on your income statement or profit and loss (P&L).

example income statement to find monthly revenue

3). Find your gross profit %

Finally, find gross profit using this formula: Gross proft = Revenue – (COGS) x 100

How to Shorten your Payback Period

There are a number of ways you can shorten your payback period by pulling on the correct CAC and LTV levers:

shorten payback period by pulling on these CAC and LTC levers

Payback Period Pitfalls

While payback period is easy to understand it does have a couple of drawbacks when you’re using it to judge an investment:

  • Future value of cash over time is ignored.
  • When calculating payback period, generally you are ignoring any future cash inflow after the initial investment has been recovered.

Need help understanding how to calculate your payback period correctly? That’s what we’re here for. Get in touch to learn more about how we can help.


Learn more about how tracking the right KPIs with our fractional CFO services can help your business grow. 

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