What is a Payout
Payout refers to the expected financial return or monetary disbursement from an investment or annuity. It may be expressed on an overall or periodic basis as either a percentage of the investment's cost or in a real dollar amount. Payout can also refer to the period of time 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."
Breaking Down 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 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 return than dividends and share buybacks.
The payout ratio is calculated with the following formula: total dividends / net income. The payout ratio can also include share repurchases, in which case the formula is: (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
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 a longer period of time are considered less desirable than projects that take a shorter time 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.