Interest IncomeIncome earned from lending money

The primary purpose of starting and running a business is to generate profits.

This statement still applies to banks, other financial institutions, and other money lenders.

They still are businesses after all.

And just like any other business, they need to earn revenue in order to stay afloat.

Not only that, but they also need to earn profits to grow.

Now, when we talk of a bank, you’d think that it’s a place where you can put your money for safekeeping, right?

Well, you’re correct to think that.

Banks are indeed places where you can safely keep your money.

But, how do banks earn revenue?

It’s certainly not from safekeeping your money.

They pay you for depositing your money with them after all.

Rather, banks, and most likely other financial institutions, earn revenue by lending money.

Are you familiar with loans?

You know, when a bank lends you money that you will eventually have to repay in full (and more)?

That’s primarily how they earn money.

When it comes to loans, aside from repaying the amount lent to you, you’d have to make additional payments too.

We commonly refer to these as interest payments.

On the part of the borrower, interest is an expense (a.k.a. interest expense).

But on the part of the lender, interest is revenue (a.k.a. interest income).

Interest income will typically form a huge part of a lender’s (e.g. bank, credit union) total revenue.

In this article, we will be discussing what interest income is.

How does one earn interest income?

And is this type of income exclusive to lenders?

Can other businesses earn interest income?

Can an investor earn interest income?

How does one calculate interest income?

Let’s try to answer these questions and more as we go along with the article.

What is Interest Income?

Interest income refers to the revenue earned by lending money to other businesses or individuals.

For example, a bank lends its money to a private business.

The business will then have to repay the bank the whole amount of the loan plus interest.

These interest payments generate interest income for the bank.

Interest income is not exclusive to businesses that have money lending as their main business operation.

Other types of businesses may earn interest income so long as they lend some of their money for cash.

For example, business C, a hardware store, lends business A $500.

In exchange, business A promises to pay $505 at a future date.

Here, the $5 additional payment is technically interest.

As such, business C still earns interest income even if it is not primarily engaged in money lending.

Even individuals can earn interest income.

Simply depositing your money in a bank already earns you interest income.

For example, let’s say that a bank offers 3% interest annually for regular savings.

If you deposit $1,000 in that bank and let it stay there for a year, you’ll earn $30 as interest income.

Interest income may also refer to the returns an investor receives from his/her investment, particularly those in debt securities (e.g. bonds, certificate of deposit).

For example, an investor purchases a $1,000 bond that has a term of 3 years.

The bond is set to pay 4.5% interest until its maturity.

This means that the investor will earn $45 interest income annually until the maturity of the bond.

For lenders such as banks and other financial institutions, interest income will typically form a huge part of their total revenue.

Lending money to earn interest is their main way of generating revenue after all.

Where can you find Interest Income in the Financial Statements?

Since interest income is an income account, you’ll typically find it on a business’s income statement.

The question now is where on the income statement does “interest income” appear?

In a typical income statement, there are two types of income: “revenue (or income from operations)”, and “other income”.

You’ll normally find “revenue” on the top part of an income statement.

On the other hand, you’ll usually find “other income” on the lower part of an income statement.

So, where does “interest income” appear on an income statement?

The answer to this question is: it depends on the nature of the business’s main operations.

If earning interest income is a major part of the business’s revenue generation, then you’ll find “interest income” in the revenue section of its income statement.

For example, a bank mainly earns revenue by lending its money to earn interest.

In such a case, you’ll find “interest income” in the revenue section of the bank’s financial statement.

If earning interest income is more of an extra, then “interest income” will appear in the other income section of the business’s income statement.

What this means is that earning interest income isn’t a part of the business’s main operations.

Let’s go back to the hardware store example above.

Business C earned $5 interest income just by lending $500 to business A.

However, since earning interest income isn’t a part of business C’s main operations, it’ll be incorrect to include such an income in the revenue sections of its income statement.

As such, this $5 interest income will instead appear in the other income section.

So to summarize, you can find “interest income” in a business’s income statement.

Depending on the nature of the business’s main operations, you can find it in the “revenue” or “other income” section.

Interest Income VS Interest Expense

Interest will either be income or expense depending on the concerned party.

For the borrowing party, interest is an expense. For the lending party, interest is an income.

Interest expense is the cost of borrowing money from lenders such as banks, other financial institutions, and other lenders.

In exchange for a quick injection of cash, the borrower has to pay interest on top of repaying the borrowed amount.

Interest expense is avoidable if a business decides to not borrow money to finance its operations.

However, if a business to decides to borrow money to finance a large expenditure, then it will typically incur interest expenses.

On the hand, interest income is the revenue that you earn from lending money.

It’s the opposite of interest expense.

Lenders such as banks and other financial institutions earn interest income from their money lending operations.

The simple act of depositing your money in a bank may also count as lending money.

The bank will use the money you deposited for its operations.

So technically, by depositing your money, you’re lending money that the bank will use.

In an income statement, interest income and interest expense may appear separately.

However, a business may decide to combine them.

In such a case, they’ll appear as “Interest Income – Net” or “Interest Expense – Net”.

“Interest Income – Net” will appear if the interest income is greater than the interest expense.

On the other hand, “Interest Expense – Net” will appear if the interest expense is greater than the interest income.