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Interest Income

The amount paid to an entity for lending its money or letting another entity use its funds

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 placed on 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 was lent.

 

Interest Income

 

Where is the interest income presented?

Interest income is usually a 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 the “Income from Operations” and the “Other Income” are written separately. In such an event, the presentation of the said income will largely depend on the business’ primary operations.

If, for example, the income from interest is a major source of funds for the company, interest income falls under “Income from Operations.” If the opposite is true, it is considered “Other Income.”

 

Example of interest income

Interest income does not necessarily mean an individual offering his money to a lending institution to allow other people borrow it nor does it always mean a multinational company lending its funds to a smaller company to help it grow.

A very simple example of interest income that happens every day is when an individual deposits money into his savings account and decides to leave it untouched for several months or years. The thing is that money won’t just sit idly in his account because the bank itself will use it to lend to borrowers with the promise of paying a specific interest to the account holder.

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 though that banks only use what is called “fractional banking,” which means only a part of the deposit is taken by the bank.

 

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 it into a savings account in a bank or by getting certificates of deposits with maturities. Interest is earned by the company and the amount is reflected in the income statement as interest income.
  • Interest expense, on the other hand, is the opposite of interest income because it is the cost of borrowing money from financial institutions, banks, bond investors, and from other lenders. Interest expense is incurred in order to help a company with its operations such as the purchase of additional machinery, plant, and property, as well as the acquisition of competitors or other companies.

In some cases, businesses report the interest expense and interest income separately, while still some others combine them and label them as “Interest Income – Net” or as “Interest Expense – Net.” Deciding on which of the two labels is to be used depends on which one carries more value.

 

Interest income vs. Dividend

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 profit and 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:

  1. Take the annual interest rate and convert the percentage figure to decimal by simply dividing it by 100. For example, an interest rate of 2% divided by 100 is 0.02.
  2. 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.
  3. Multiply the figure by the amount in the account to complete the calculation. Let’s say the principal amount borrowed is $5,000; multiplying the figure with 0.06 will give us $300. Thus, $300 is the interest income for the money lent in 3 years.

 

Final word

Interest income is one of the many sources of income not only for businesses but for individuals as well. Simply putting some money in the bank is a good way to start earning interest though the interest rate is not very high.

 

More resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Annual Percentage Rate (APR)
  • Effective Annual Interest Rate Calculator
  • Expected Return
  • Federal Deposit Insurance Corporation (FDIC)

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