The amount paid to an entity for lending its money or letting another entity use its funds
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What is Interest Income?
Interest income is the amount paid to an entity for lending its money or letting another entity use its funds. On a larger scale, interest income is the amount earned by an investor’s money that he places in an investment or project. A very simple and basic way of computing it is by multiplying the principal amount by the interest rate applied, considering the number of months or years the money is lent.
Where is the Interest Income Presented?
Interest income is usually taxable income and is presented in the income statement for the simple reason that it is an income account. Usually, the two categories in the income statement, namely “Income from Operations” and “Other Income” are listed separately. In such an instance, the presentation of interest income will largely depend on the nature of the business’ primary operations.
If, for example, the income from interest is a major source of funds for the company, then it falls under “Income from Operations.” If it is not a primary revenue source, then it is classified as “Income from Investments” or “Other Income.”
Example of Interest Income
A very simple example of interest income that happens every day is when an individual deposits money into a savings account and decides to leave it untouched for several months or years. The money won’t just sit idly in his account, because the bank will use it to lend money to borrowers. The bank will earn interest by lending money out, but will also pay interest to holders of deposit accounts.
At the end of every month, the account statement will reflect the interest that the bank pays for borrowing the account holder’s money. It is important to note that banks use what is called “fractional banking,” which means that only a part of customer deposit accounts can be used by the bank as lending funds. The bank must retain a certain level – known as the reserve – of deposit account funds. It cannot legally loan out all the funds that customers have deposited with it.
Interest Income vs. Interest Expense
The main difference between interest income and interest expense is outlined below:
- Interest income is money earned by an individual or company for lending their funds, either by putting them into a deposit account in a bank or by purchasing certificates of deposits.
- Interest expense, on the other hand, is the opposite of interest income. It is the cost of borrowing money from financial institutions, banks, bond investors, or other lenders. Interest expense is incurred in order to help a company fund its operations, such as the purchase of additional machinery, plant, and property, or the acquisition of competitors or other companies.
In some cases, businesses report the interest expense and interest income separately, while others combine them and label them as “Interest Income – Net” or as “Interest Expense – Net.”
Interest Income vs. Dividend Income
Interest income is not the same as dividend income. The former is an amount earned for letting another person or an organization use one’s funds, while the latter is an amount that comes from the company’s profits and that is paid to the organization’s equity shareholders and preferred shareholders.
How to Compute Interest Income
Simple interest can be computed in very simple steps. Let’s look at the process below:
- Take the annual interest rate and convert the percentage figure to a decimal figure by simply dividing it by 100. For example, an interest rate of 2% divided by 100 is 0.02.
- Use the decimal figure and multiply it by the number of years that the money is borrowed. For example, we can multiply 0.02 by 3 years and get 0.06.
- Multiply that figure by the amount in the account to complete the calculation. Let’s say the principal amount borrowed is $5,000; multiplying the figure by 0.06 will give us $300. Thus, $300 is the interest earned for the money lent for a period of 3 years.
Final Word
Interest income is one of the many sources of income for businesses and individuals. Simply putting some money in the bank is a good way to start earning interest, although the interest rate for a standard savings account is not very high.
More Resources
Thank you for reading CFI’s guide to Interest Income.To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:
FAQs
There are a few different ways to invest your money to earn interest and live off of that income. The most popular investments are bonds, certificates of deposit (CDs) and annuities. The interest that you'll earn will depend on the amount of money you have in your account when you go to live off of that interest.
How to do 50/30/20? ›
Key Takeaways
- The 50/30/20 budget rule states that you should spend up to 50% of your after-tax income on needs and obligations that you must have or must do.
- The remaining half should be split between savings and debt repayment (20%) and everything else that you might want (30%).
Key takeaways: The typical American making $40,480 a year needs at least $826k invested with a 4.9% annual return to live off interest alone. Estimate how much you need invested to live off interest with the formula: Annual income / Annual interest rate = Savings goal.
Can you live off the interest of $500,000? ›
The short answer is yes, $500,000 is enough for many retirees. The question is how that will work out for you. With an income source like Social Security, modes spending, and a bit of good luck, this is feasible. And when two people in your household get Social Security or pension income, it's even easier.
Can you live off interest of $1 million dollars? ›
Once you have $1 million in assets, you can look seriously at living entirely off the returns of a portfolio. After all, the S&P 500 alone averages 10% returns per year. Setting aside taxes and down-year investment portfolio management, a $1 million index fund could provide $100,000 annually.
What qualifies as interest income? ›
Interest income is money earned from investments—like corporate and municipal bonds—bank accounts, like checking and savings accounts, and more. These accounts and investments may earn interest income or ordinary dividends and are, therefore, subject to federal tax: Checking accounts. Saving accounts.
Is $4000 a good savings? ›
Are you approaching 30? How much money do you have saved? According to CNN Money, someone between the ages of 25 and 30, who makes around $40,000 a year, should have at least $4,000 saved.
What is the 75 15 10 rule? ›
In his free webinar last week, Market Briefs CEO Jaspreet Singh alerted me to a variation: the popular 75-15-10 rule. Singh called it leading your money. This iteration calls for you to put 75% of after-tax income to daily expenses, 15% to investing and 10% to savings.
Is 50/30/20 realistic? ›
The 50/30/20 rule can be a good budgeting method for some, but it may not work for your unique monthly expenses. Depending on your income and where you live, earmarking 50% of your income for your needs may not be enough.
How do millionaires live off interest? ›
Living off interest involves relying on what's known as passive income. This implies that your assets generate enough returns to cover your monthly income needs without the need for additional work or income sources. The ideal scenario is to use the interest and returns while preserving the core principal.
Interest on $100,000
Even with a well-diversified portfolio and minimal living expenses, this amount is not high enough to provide for most people. Investing this amount in a low-risk investment like a savings account with a rate between 2% to 2.50% of interest each year would return $2,000 to $2,500.
Is $2m enough to retire? ›
If you have multiple income streams, a detailed spending plan and keep extra expenses to a minimum, you can retire at 55 on $2 million. However, because each retiree's circ*mstances are unique, it's essential to define your income and expenses, then run the numbers to ensure retiring at 55 is realistic.
Can I retire at 62 with $400,000 in 401k? ›
If you have $400,000 in the bank you can retire early at age 62, but it will be tight. The good news is that if you can keep working for just five more years, you are on track for a potentially quite comfortable retirement by full retirement age.
What is the average Social Security check? ›
Social Security offers a monthly benefit check to many kinds of recipients. As of December 2023, the average check is $1,767.03, according to the Social Security Administration – but that amount can differ drastically depending on the type of recipient. In fact, retirees typically make more than the overall average.
Where can I retire on $2000 a month in the United States? ›
5 US Cities Where You Can Retire on $2,000 a Month
- Chiang Mai, Thailand. Advantages: Very inexpensive. ...
- San Juan, Puerto Rico. Advantage: In the United States. ...
- Claremont, New Hampshire. A couple who found a place to retire on $2,000 per month. ...
- Decatur, Indiana. Advantages: Potentially low rent. ...
- El Paso, Texas.
In most cases $300,000 is simply not enough money on which to retire early. If you retire at age 60, you will have to live on your $15,000 drawdown and nothing more. This is close to the $12,760 poverty line for an individual and translates into a monthly income of about $1,250 per month.
Can you live off interest of 800k? ›
An $800k nest egg can provide income for over 25 years in retirement if you limit annual withdrawals to around $32,000 (4% rule).
How much interest would $2 million earn? ›
A $2 million nest egg can provide $80,000 of annual income when the principal gives a return of 4%. This estimate is on the conservative side, making $80,000 a solid benchmark for retirement income with this sum of money.
