Every investment is evaluated with two simple questions: How much does it return per year, and how long will it take to get my money back? If you can answer both with real figures before you sign, the decision is made calmly. If you can't, the investment isn't ready for a decision; it's still just a wish.
The first question is the annual return. How much extra money the investment brings in or saves over a year, compared to its cost. A device that costs 500,000 LEK and brings in 300,000 LEK per year has an annual return of 60%. The second question is the payback period. In how many months is the invested money fully returned to your cash register? This question protects liquidity, because until then the business operates with less cash on hand.
Keith Cunningham, in The Road Less Stupid, says that big money isn't lost for lack of ideas, but for lack of thinking time. He calls the cost of hasty decisions the "foolishness tax." Half an hour with paper and pencil before making an investment is the cheapest insurance you'll ever buy.
A store in Tirana is considering purchasing a new packaging machine priced at 500,000 LEK. The machine saves labor and materials, totaling 25,000 LEK per month.
The payback period is 500,000 divided by 25,000, so 20 months. The annual return is 25,000 multiplied by 12, which is 300,000 LEK per year, which on an investment of 500,000 LEK yields 601 TP3T per year. On paper it looks great.
This is where Daniel Kahneman's planning fallacy comes in. People regularly underestimate the time and cost of their plans, even when they're aware of this tendency. Therefore, our example goes one step further. We add a 20% reserve to the cost, so we take the investment at 600,000 LEK including installation, transportation, and unforeseen stoppages. And we expect the more conservative saving of 20,000 LEK per month in the first year. With these figures, the payback period is 30 months and the annual return is about 40%. If the investment is worthwhile even in the conservative scenario, then it's a sound decision. If it's only worthwhile in the optimistic scenario, wait or negotiate the price.
At the Resource Center you'll find a simple investment worksheet. Enter the total cost, the actual monthly return, and the sheet will calculate the payback period and annual return, along with a conservative scenario. You only need to fill it out once, and you'll have a method for every future investment.
The payback period is calculated as the initial investment divided by the incremental net monthly cash flow. Simple annual return is calculated as the annual net cash flow divided by the investment. For investments with a life of 2 to 3 years, the accurate method is net present value using a discount rate equal to the business's cost of capital, or the internal rate of return compared to that cost. In Albanian small-business practice, where capital is often the owner's, the minimum acceptable rate is the return the owner earns from the best safe alternative, plus a risk premium. Be careful to distinguish between cash flow and accounting profit. Depreciation reduces profit, but it does not leave the cash register. The investment decision is made based on cash flow, while the tax effect of depreciation is handled separately according to the applicable tax rates.
There is no one-size-fits-all threshold for every business. As a practical guideline, small equipment is expected to pay back within 12 to 24 months, while large investments within their useful life with ample buffer. The longer the period, the more it strains liquidity.
Even there, a numerical link is required, even if it's only approximate. More customers, a slightly higher price, or staff who stay longer. If no link can be found, the decision is treated as a conscious expense, not as an investment.
If you have an investment on the table and want to review the numbers with a second pair of eyes, we'll calculate it together. Find us at Contact page or see how we work at offer.
We take care of accounting and taxes, so you can save time, money, and focus on growing your business.
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