Payback period

What it means

Payback period answers a practical question: how many years of the outlet's profit will it take to earn back the money put in. It divides the total investment by the annual profit or net cash flow the outlet generates.

A shorter payback means capital is recovered sooner and less is exposed to risk over time, while a long payback ties up money and leaves the franchisee vulnerable to changes in trading conditions, rent or fees over a longer horizon.

It is a useful first screen but a rough one. It ignores the timing of cash flows and what happens after payback, and it depends entirely on the accuracy of the total investment and profit figures fed into it, which for a new outlet are estimates.

In practice

Calculate payback against realistic, not optimistic, profit, and remember that a new outlet's early years often earn less than a mature one, which lengthens real payback beyond a simple division.

Compare payback against the length of the franchise term and the lease. A payback period that stretches close to the end of the agreement leaves little time to earn a return on the capital once it is finally recovered.

A real example

A franchisee invests $410,000 in total to open an outlet that, once established, nets about $85,000 a year. On a simple basis the payback period is a little under five years, but because the first two years earn less while sales ramp up, the realistic payback is closer to six years, well within a ten-year franchise term but worth weighing against the lease.

Payback period — FAQs