What Is a Payout? Definition, How It Works, Types, and Examples

What Is a Payout?

Payouts refer to the expected financial returns or monetary disbursements from investments or annuities. A payout may be expressed on an overall or periodic basis and as either a percentage of the investment's cost or in a real dollar amount.

A payout can also refer to the period in which an investment or a project is expected to recoup its initial capital investment and become minimally profitable. It is short for "time to payout," "term to payout," or "payout period."

Key Takeaways

  • Payouts refer to the anticipated financial returns or distributions from investments or annuities.
  • In terms of financial securities, payouts are the amounts received at certain periods, such as monthly for annuity payments.
  • A payout may also refer to the capital budgeting tool used to determine the time it takes for a project to pay for itself.
  • Companies can distribute earnings to investors through the issuance of dividends and share buybacks.
  • The payout ratio is the rate of income paid out to investors in the form of distributions.

Understanding Payout

In terms of financial securities, such as annuities and dividends, payouts refer to the amounts received at given points in time. For example, in the case of an annuity, payouts are made to the annuitant at regular intervals, such as monthly or quarterly.

Payout Ratio as a Measure of Distribution

There are two main ways that companies can distribute earnings to investors: dividends and share buybacks. With dividends, payouts are made by corporations to their investors and can be in the form of cash dividends or stock dividends. The payout ratio is the percentage rate of income the company pays out to investors in the form of distributions. Some payout ratios include both dividends and share buybacks, while others only include dividends.

For example, a payout ratio of 20% means the company pays out 20% of company distributions. If company A has $10 million in net income, it pays out $2 million to shareholders. Growth companies and newly formed companies tend to have low payout ratios. Investors in these companies rely more on share price appreciation for returns than dividends and share buybacks.

The payout ratio is calculated with the following formula:

  • Payout ratio = total dividends / net income

The payout ratio can also include share repurchases, in which case the formula is as follows:

  • Payout ratio = (total dividends + share buybacks) / net income

The cash amount paid out to dividends can be found on the cash flow statement in the section titled cash flows from financing. Dividends and stock repurchases both represent an outflow of cash and are classified as outflows on the cash flow statement.

Payout and Payout Period as a Capital Budgeting Tool

The term "payout" may also refer to the capital budgeting tool used to determine the number of years it takes for a project to pay for itself. Projects that take longer are considered less desirable than projects with a shorter period.

The payout, or payback period, is calculated by dividing the initial investment by the cash inflow per period. If company A spends $1 million on a project that saves $500,000 a year for the next five years, the payout period is calculated by dividing $1 million by $500,000. The answer is two, which means the project will pay for itself in two years.

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