What is NPV, IRR, and Payback Period? A Non-Accountant's Guide to Feasibility Metrics

You've got a business idea. You've done some research. You're pretty sure it could work. But then someone — a potential investor, a bank loan officer, your accountant — asks: "What's the NPV? What IRR are you projecting? What's the payback period?"

If those three acronyms make you freeze, you're not alone. Most entrepreneurs don't come from a finance background. But these three metrics are the language that investors and banks use to evaluate whether an investment is worth making. Understanding them doesn't require an accounting degree — it just requires the right explanation.

Let's break each one down with simple examples, zero jargon, and practical application to real business decisions.

Why These Three Metrics Matter

Before we dive into the definitions, let's understand why these specific metrics exist.

When you invest money in a business, you're making a bet about the future. You're putting money in today with the expectation of getting more money back over time. The fundamental question is: Is the money I'll get back worth more than the money I'm putting in?

That sounds simple, but it's not — because money today is worth more than money in the future. A dollar in your pocket right now is more valuable than a dollar you'll receive in five years. Why? Because you could invest that dollar today and earn returns on it. Plus there's risk — the future dollar might never arrive.

NPV, IRR, and payback period are three different ways of answering the same fundamental question: Is this investment worth it? Each approaches the question from a different angle, and together they give you a complete picture.

Net Present Value (NPV) — The Big Picture Metric

What It Is

Net Present Value is the total value that an investment creates (or destroys) in today's dollars. It takes all the money you expect to receive in the future, adjusts each payment for the fact that future money is worth less than present money, and then subtracts your initial investment.

If NPV is positive, the investment creates value — you'll end up richer than if you hadn't invested. If NPV is negative, the investment destroys value — you'd be better off putting your money somewhere else.

The Lemonade Stand Example

Let's say you're thinking about investing $1,000 in a lemonade stand. You expect it to generate $400 per year for four years. Seems like a great deal, right? $400 × 4 = $1,600 back on a $1,000 investment.

But wait. You need to account for the time value of money. Let's say your discount rate is 10% — this represents what you could earn elsewhere, plus some risk premium.

Here's the calculation:

The NPV is +$267. That means this investment creates $267 of value in today's terms, above and beyond the return you'd get from your alternative investment. It's a green light.

Now imagine the same investment but with a much higher discount rate of 25% (maybe because the lemonade stand is in a risky location). The present values would shrink, and the NPV might turn negative — signalling that the investment doesn't adequately compensate you for the risk.

What "Good" NPV Looks Like

The rule is simple: Positive NPV = Good. Negative NPV = Bad. Higher NPV = Better.

There's no universal benchmark for "how positive" NPV should be — it depends on the scale of the investment. A $50,000 NPV on a $100,000 investment is excellent. A $50,000 NPV on a $10 million investment is marginal.

What matters is that it's positive after using an appropriate discount rate that reflects your cost of capital and the investment's risk level.

Why Most AI Business Plan Tools Don't Calculate NPV

Here's something important: the vast majority of AI business plan generators don't calculate NPV at all. They produce revenue projections and P&L statements, but they don't discount future cash flows to present value. This means their financial analysis fundamentally overstates the attractiveness of long-term investments.

A 5-year revenue projection that shows $2 million in profit sounds great. But if most of that profit comes in years 4 and 5, and you're investing $1 million upfront, the NPV might actually be negative once you account for the time value of money. Without NPV, you'd never know.

Internal Rate of Return (IRR) — The Percentage Metric

What It Is

If NPV tells you the total value an investment creates, IRR tells you the annual percentage return it generates. Technically, IRR is the discount rate at which the NPV equals exactly zero. In practical terms, it's the annualised return rate of your investment.

Think of it like the interest rate on a savings account, but for your entire business investment. If your business has an IRR of 25%, it means your investment is generating a 25% annual return.

Why It Matters

IRR is powerful because it lets you compare completely different investments on the same scale. A hotel development, a SaaS startup, and a rental property can all be expressed as a single percentage return, making comparison straightforward.

Investors use IRR as a hurdle rate. They set a minimum acceptable return — typically based on their cost of capital plus a risk premium — and only invest in opportunities that exceed it.

These ranges vary by market, economic conditions, and investor risk appetite. But they give you a sense of what "good" looks like.

A Practical Example

You're evaluating two potential businesses:

Business A generates more total cash ($245,000 vs $100,000), but which is the better investment?

Business A has an IRR of approximately 14%.

Business B has an IRR of approximately 20%.

Despite generating less total cash, Business B is a better investment because your money works harder — each dollar invested earns a higher annual return. Plus, your capital is tied up for a shorter period, reducing risk.

This is exactly the kind of insight that raw revenue projections can't give you — and exactly why IRR matters.

IRR Limitations

IRR isn't perfect. It can produce misleading results for investments with non-conventional cash flows (where you invest additional money in the middle of the project). It can also make short-term investments look artificially attractive compared to long-term ones.

That's why you should always use IRR alongside NPV, not instead of it. NPV tells you the total value created; IRR tells you the efficiency of the return. Together, they give you the complete picture.

Payback Period — The Simplicity Metric

What It Is

Payback period is the simplest of the three metrics. It answers one question: How long until I get my money back?

If you invest $100,000 and generate $25,000 per year in net cash flow, your payback period is 4 years. That's it.

Why It Matters

Payback period captures something that NPV and IRR don't fully convey: risk through time. The longer your money is tied up in an investment, the more things can go wrong. Economic downturns, competitive changes, regulatory shifts, technological disruption — all become more likely over longer time horizons.

A business with a 2-year payback period is inherently less risky (in terms of capital recovery) than one with a 7-year payback period, even if the latter has a higher NPV. Once you've recovered your investment, every dollar after that is pure profit. Until you've recovered it, you're in the risk zone.

Banks care deeply about payback period because it tells them how long their loan is at risk. Investors care because it tells them when they start seeing positive returns.

Payback Period Benchmarks

These are guidelines, not rules. A 5-year payback for a hotel is normal given the high CAPEX; a 5-year payback for a food truck would be a red flag.

Simple vs Discounted Payback

There are two versions of payback period:

For feasibility studies, discounted payback is more appropriate because it reflects reality more accurately. SimpleFeasibility calculates discounted payback automatically.

How the Three Metrics Work Together

Each metric tells you something different:

A healthy feasibility study shows all three in positive territory: positive NPV (value is created), IRR above your hurdle rate (returns are adequate), and payback period within your comfort zone (capital isn't locked up too long).

When the metrics disagree, it usually signals something important. A high NPV but long payback period might indicate a slow-building investment that creates significant value eventually but ties up capital for years. A high IRR but low NPV might indicate a small-scale opportunity that's efficient but won't generate life-changing returns.

A Complete Example

Let's evaluate a proposed 80-seat restaurant:

• Initial Investment: $350,000 (fit-out, equipment, working capital)
• Annual Net Cash Flow (Years 1-2): $60,000
• Annual Net Cash Flow (Years 3-5): $90,000
• Discount Rate: 12%

This is the level of analysis that investors and banks expect to see. Revenue projections alone don't cut it. P&L statements without NPV don't cut it. You need all three metrics to tell the complete story.

Why This Matters for Your Feasibility Study

If you're writing a feasibility study — or evaluating one generated by an AI tool — check for these three metrics. If they're missing, the financial analysis is incomplete.

Most AI business plan generators produce revenue projections and basic P&L statements. Very few calculate NPV. Almost none calculate IRR. And payback period, when included, is usually simple payback without discounting.

This is a significant gap. A feasibility study without NPV, IRR, and payback period is like a medical diagnosis without blood test results — it might be directionally correct, but it's missing the critical data that confirms the conclusion.

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