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Payback period vs. break even

Pharma F&E
New answer on Nov 11, 2023
6 Answers
1.3 k Views
Anonymous A asked on Jun 29, 2023

Why is the term "payback period" confused with a "break-even analysis" here? Isn't the initial investment decisive for the payback period?

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Cristian
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Content Creator
replied on Jun 30, 2023
#1 rated MBB & McKinsey Coach

Hi there, 

Breakeven is a point. So it's usually expressed as a numerical figure suggesting volume.

Payback period is a period. So it's usually expressed as a time figure suggesting years. 

Best,
Cristian

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Emily
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replied on Jun 30, 2023
300+ coached cases | Former McKinsey interviewer + recruiting lead| End-to-end prep in 2 weeks

The terms "payback period" and "break-even analysis" are often used in financial discussions, but they refer to different concepts. While it's true that the initial investment plays a role in the payback period, it is not the sole determining factor. Let's clarify the differences between these two terms:

Payback Period: The payback period is a financial metric used to determine the length of time required for an investment to generate enough cash flows to recover the initial investment. It represents the time it takes to "pay back" the investment. The payback period is calculated by dividing the initial investment by the average annual cash inflows generated by the investment. It provides an indication of how quickly an investment will recoup its initial costs.

Break-Even Analysis: Break-even analysis, on the other hand, is a tool used to determine the point at which revenues equal expenses, resulting in zero profit or loss. It helps identify the level of sales or production volume needed to cover all costs and reach the break-even point. The break-even point is calculated by dividing fixed costs by the contribution margin (selling price per unit minus variable cost per unit).

The confusion between these terms might arise from their association with financial analysis and decision-making. While both concepts involve financial considerations, they address different aspects of an investment or business. The payback period focuses on recovering the initial investment, while break-even analysis examines the point at which revenues and costs are equal.

It's important to use these terms accurately and understand their distinct meanings to avoid confusion and ensure effective financial analysis and decision-making.

I hope this clarifies the differences between the payback period and break-even analysis. If you have any further questions, feel free to ask!

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Andi
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replied on Jun 30, 2023
BCG 1st & Final Round interviewer | Personalized prep with >95% success rate | 7yrs coaching | #1 for Experienced Hires

Hi there - 

thanks for the question - Break Even Point and Payback Period are 2 concepts that frequently get mixed up by candidates, as they are fairly similar in nature.

  • Break Even Analysis measures how much Volume of a product or Service needs to be sold to “break even”, i.e. where Revenues = Cost → Profit = 0. Focus here is the Quantity aspect, not the time it takes.
  • Payback Period measures how much Time it will take until an investment is recouped and the business / project starts making profit. Focus here is the Duration (time) it takes.

Both methods take investment into account.

The case you are referencing requires the candidate to calculate Payback Period, which is an indicator commonly used in Pharma.

Hope this clarifies.

Regards, Andi

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Clara
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replied on Nov 11, 2023
McKinsey | Awarded professor at Master in Management @ IE | MBA at MIT |+180 students coached | Integrated FIT Guide aut

Hello!

Precisely for the high amount of questions (1) asked by my coachees and students and (2) present in this Q&A, I created the “Math & Formulas - Economic and Financial concepts for MBB interviews”, recently published in PrepLounge’s shop (https://www.preplounge.com/en/shop/prep-guide/economic_and_financial_concepts_for_mbb_interviews).

After +5 years of candidate coaching and university teaching, and after having seen hundreds of cases, I realized that the economic-related knowledge needed to master case interviews is not much, and not complex. However, you need to know where to focus! Hence, I created the guide that I wish I could have had, summarizing the most important economic and financial concepts needed to solve consulting cases, combining key concepts theorical reviews and a hands-on methodology with examples and ad-hoc practice cases.

It focuses on 4 core topics, divided in chapters (each of them ranked in scale of importance, to help you maximize your time in short preparations):

  • Economic concepts: Profitability equation, Break even, Valuation methods (economic, market and asset), Payback period, NPV and IRR, + 3 practice cases to put it all together in a practical way. 
  • Financial concepts: Balance sheet, Income statement/P&L and Performance ratios (based on sales and based on investment), +1 practice case
  • Market structure & pricing: Market types, Perfect competition markets (demand and supply), Willingness to pay, Pricing approaches, Market segmentation and Price elasticity of demand, +1 practice case
  • Marketing and Customer Acquisition: Sales funnel, Key marketing metrics (CAC and CLV) and Churn, +1 practice case

Feel free to PM me for disccount codes for the guide, and I hope it helps you rock your interviews! 

 

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Ian
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replied on Jul 01, 2023
#1 BCG coach | MBB | Tier 2 | Digital, Tech, Platinion | 100% personal success rate (8/8) | 95% candidate success rate

Hi there,

The others have defined it well. Also remember that you want to do the following in general:

  1. Learn the core formulas + business terms
  2. BUT WHEN you get one in a live case that you don't know, be ready to figure it out on the spot by asking strong, assertive questions (this is what consultants do)
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Pedro
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replied on Jun 30, 2023
Bain | Roland Berger | EY-Parthenon | Mentoring Approach | 30% off first 10 sessions in May| Market Sizing | DARDEN MBA

Payback period is how long it takes to recover your initial investment. In that regard it is the investment break even. This is relevant when you are making an investment decision.

That is different from the operational breakeven (i.e. when revenues surpass costs). This is relevant when you are making a “business” / operational decision. For how long it takes to reach this operational breakeven one would use the expression “time to break even” or “break even period”.

Of course, it is always better to clarify with the interviewer what is exactly the concept being used.

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Cristian gave the best answer

Cristian

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