As an entrepreneur, you have to keep investing to stay competitive . But an investment always has to be well thought out. That is why it is important for you to know how long it will take for you to make an investment. The amortization calculation will help you with such a calculation .
Definition of the amortization calculation
The term amortization calculation is a static investment calculation . In addition to the static investment calculation, there is also a dynamic one . The target value of the amortization calculation is the amortization period. In contrast to other static methods for an investment calculation, the amortization calculation is based on payments. The main focus is on liquidity , security and independence . For you, the aim of the amortization calculation is to quickly get your funds back into your company for the investment.
How are amortization and amortization calculation related?
According to definitionexplorer.com, the terms amortization and amortization calculation are closely related when it comes to calculating when you will have your invested capital back in the company. In this way it is possible for you to limit the risk that almost every investment brings with it. It is therefore important to define the two terms and to know their importance for an investment and its calculation.
|The term amortization describes the time it takes for the capital used for an investment to flow back completely into a company. A quick amortization helps to better limit and estimate the risk of an investment. The probability of a positive return on an investment is significantly higher.
|The amortization calculation is used to calculate the time of amortization. Interest effects are not taken into account in the calculation. The amortization calculation is a static method of investment calculation. If you reach the time of amortization for an investment, then the static profitability is just zero.
Calculation of the payback period
The amortization calculation to determine the amortization period can also be done in two different ways. There is a static and a dynamic amortization calculation. In practice, one also speaks of the average and the cumalation method .
Calculation according to the average method
To calculate the payback period using the average method, you need to divide the original capital employed by the average returns. The return flows into your company are also known as the investment cash flow . You can basically derive this cash flow from the profit of a period. When calculating the amortization, however, you must note that you do not only take into account the profit for the period to amortize the capital. You also have to include depreciation, which is only intended to repatriate capital, in the calculation.
If you do that, the investment cash flow is shown as follows:
|Period profit or cost savings per period
|Average depreciation over a period
|Investment cash flow
When calculating your profit for the period, you must note that the interest costs have already been deducted. You must always take into account the interest on the capital invested in the amortization period in the amount of the calculated interest rate. This then results in the calculation using the average method.
Calculation according to the accumulation method
Calculating using the accumulation method is the second way to calculate the payback period. This method only takes into account the fact that there may be different levels of return flow during the term of an investment. Therefore, you have to add the returns here step by step, starting with the first period. In this case, for you, the duration of the amortization represents the period in which total returns exceed the capital employed.
In plain language, this means that you have to accumulate the returns until you have achieved amortization. With the method of dynamic amortization calculation, you can determine the time of the amortization more precisely. This method is also useful if you have purchased several goods. Here you are able to determine each individual payback time. This is not possible with the static or the average method.
Reasons for the amortization calculation
The amortization calculation clearly pursues the goal of being able to weigh your risk more precisely in advance of an investment. Let’s take the example of machines. You are planning to buy machines for your company. Your goal with such a purchase is always that the machines have a payback period that is shorter than their service life. When it comes to capital investments , a large amount with a long payback period can be attractive, but there are also some risks hidden behind it. In order to better assess these risks and thus make them calculable, you need the amortization calculation.
As good and plausible as this may sound, there is one fact that you must not forget. Even with the most precise implementation of the amortization calculation, both static and dynamic, it is only a theoretical approach . It is always possible that your financial year either accrues interest or you have to post smaller profits than you thought. A dry spell over a longer period is also quite possible. For these reasons, a deviation from the amortization calculation and the resulting amortization period is possible at any time.
Important facts about the payback period
- Payback period = return flow of capital from an investment (purchase)
- Dynamic amortization calculation = ratio of capital to an individually calculated return flow of a year
- Static amortization calculation = ratio of capital to the average return over a year
- The amortization calculation and the resulting amortization period should help to estimate the risk of an investment (purchase)