ROI, Payback and Depreciation: One Purchase, Worked Through All Three

Payback period, ROI and depreciation each answer a different question about the same purchase, and each one, used alone, can make a decision look better or worse than it is. The clearest way to see how they fit together is to push one purchase through all three.

The purchase

A café buys an espresso machine for ₹2,40,000. It expects the machine to add ₹12,000 a month in profit (extra sales minus beans, milk and power) and to be sold for about ₹40,000 after 5 years.

Question 1: how long until it pays for itself?

Payback period = cost ÷ monthly return = ₹2,40,000 ÷ ₹12,000 = 20 months.

When cash is tight, this is the number to check first, because it says how long the cash is tied up. The Payback Period Calculator gives the same 20 months (1 year 8 months).

What payback ignores:

• Everything after month 20. A machine that paid back in 20 months and then broke would score the same as one that kept earning for 40 more.
• The time value of money. ₹12,000 received in month 18 is worth less than ₹12,000 today. Discounting each month's return at 10% a year stretches the payback to 22 months. That is still quick, but for purchases that pay back over several years the gap grows.

Question 2: was it worth it overall?

Over 5 years the machine returns 60 × ₹12,000 = ₹7,20,000, plus ₹40,000 when it's sold: ₹7,60,000 in total.

ROI = (₹7,60,000 − ₹2,40,000) ÷ ₹2,40,000 = 216.7%.

The ROI Calculator, given a cost of ₹2,40,000, a final value of ₹7,60,000 and 5 years, reports the same 216.7% and an annualized ROI of 25.9%: (7,60,000 ÷ 2,40,000)^(1/5) − 1.

The catch in annualized ROI

That 25.9% assumes all ₹7,60,000 arrives at the end of year 5, like an investment you sell. The machine doesn't work that way: it pays ₹12,000 every month from the start, and each payment could be used, or reinvested, as soon as it arrives. The return rate that accounts for *when* each rupee comes back is the internal rate of return (IRR). For these monthly cash flows it is 4.74% a month, or 74.3% a year compounded.

Both numbers are correct; they answer different questions. Use annualized ROI for something that pays out in one go at the end (land, a bond held to maturity, shares). Use IRR, or at least payback, for something that pays back in instalments. Comparing this machine's 25.9% with a fixed deposit's rate would understate it badly.

Question 3: what does it do to reported profit?

Accounting doesn't treat the ₹2,40,000 as a cost in the month you pay it. It spreads the cost over the machine's useful life as depreciation. With the straight-line method:

Annual depreciation = (cost − salvage value) ÷ useful life = (₹2,40,000 − ₹40,000) ÷ 5 = ₹40,000 a year.

So in the books the machine adds ₹1,44,000 a year of operating profit (12 × ₹12,000) but only ₹1,04,000 of profit after depreciation. The cash in the till is still ₹1,44,000; depreciation is a non-cash expense. That is why a business can look less profitable on paper in the years after a big purchase while its bank balance says otherwise. The Straight-Line Depreciation Calculator produces the schedule above.

For income tax in India, depreciation is claimed under the Income-tax Act's own rules (written-down-value rates for each block of assets), which usually give a different yearly figure from the straight-line schedule in your books. Your accountant will work out the tax figure; the straight-line one is for understanding the purchase.

Using the three together

A purchase that looks good on all four is an easy decision. When they disagree, the disagreement usually points at the real risk: a short payback with a low ROI means little is earned after the cost comes back; a high ROI with a long payback means the business has to survive years of tied-up cash first. Before any of this, the Break-Even Calculator answers the prior question: how many extra cups a month the machine needs to sell to cover its costs at all.