What is Personal Income?
Personal income refers to all the earnings being made by a household in a given year and includes various sources of earnings like salaries, wages, investment, dividends, rent, contributions being made by an employer towards any pension plan, etc.
- This concept has been used in computing the adjusted gross national income in economics. It has become a major tool for investors through which future demand for goods and services can be easily predicted. There are three measures of national income out which personal income is the one which is reported to the national income and product accounts being maintained Bureau of Economic Analysis.
- It is the measure of income that is received by the household and includes income not necessarily earned by them and may take the form of social security benefits, unemployment benefits, welfare compensation, etc.
- The undistributed share of profits not received by the individuals, indirect business taxes and contributions of employers towards the social security of its employees are some additional examples of personal income.
Personal Income Formula
- PI = Personal Income
- NI = National Income
It can also be expressed in the following forms:
The following are the two approaches that are used –
1) In the first approach, Personal Income can derive by taking the sum of all the income received by the household members.
PI = Salaries/Wages Received + Interest Received + Rent Received + Dividends Received + Any Transfer Payments
A major portion of personal income cropped up from factors of production like land, labor, capital, and entrepreneur which includes rent, salaries, wages, interest, and profits respectively. We will describe each component in detail now.
#1 – Salaries/Wages
Salaries and wages earned by individuals and households form 60% of personal income. The official term for labor according to National Income and Products Accounts are wages, salaries, and other labor incomes.
#2 – Rent
The rental income being received by the individual household members form part of the PI. The rent is collected by the owners from the properties, land, plant or any equipment’s being given on rent. The rent forms around 2 to 3% of personal income.
#3 – Interest
The official term used for interest as a component in personal income is personal interest income according to National Income and product accounts maintained by the Bureau of Economic Standards. The interest comes from bank accounts, fixed income securities or bondsBondsA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. Issuer is liable to pay the coupon (an interest) on the same. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually., any other form of a loan. Interest forms 10 to 13% portion of PI.
#4 – Profit
Profit is the share that is earned by the entrepreneur on the capital invested by him in the business. The dividend is the official entry for the profit in the personal income formula. DividendDividendDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company. varies from 2 to 4% in the personal income. There are other forms of business profit not distributed called retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. and corporate taxes on the profits.
#5 – Proprietor’s Income
In proprietorship and partnership, owners do not receive the salaries or wages instead they receive the share of profits from the partnership which is known as proprietor’s income. It forms around 10% of PI.
#6 – Transfer Payments
The above-mentioned components are the income that is earned and received. The relatively forms around 80 to 85% of personal income. The rest of 15 to 20% comes from transfer payments. Transfer payments are the income that has been received but not earned by the factors of production. Major examples of transfer payments are social security benefits, welfare payments, and unemployment compensationUnemployment CompensationUnemployment Compensation is a benefit provided by developed countries and a few developing countries to unemployed citizens who have lost their source of income due to retrenchment or layoffs..
2) In the second approach can be derived by adjusting the National Income with the income received and earned and income not earned but received.
PI = NI + Income Earned but not Received + Income Received but not Earned
#1 – Income Earned but not Received
The three major income earned but not received are undistributed profits, taxes on social security and corporate taxes. The social security taxes are the contribution being made by labors. Undistributed profits are the share of profits being retained by the business for future business opportunities. Corporate taxes are the taxes being paid by the corporations on the profits being generated by the business.
#2 – Income Received but not Earned
The three major sources of income received but not earned are social security benefits, unemployment benefits, and welfare payments. These three incomes are received by the household members from the government. Social security benefits are paid to elder citizens, disabled peoples, and retired citizens.
Unemployment compensation is being paid to the unemployed members of the household by the government to maintain the normal standard of living. Last but not the least welfare benefits are being paid by the government to the poor sections of households.
Now we will explain the concept with the following examples.
Let’s assume individual James has the following sources of income.
Use the given data for the calculation
PI = Salaries + Interest Income + Rent Income + Dividend Income + Transfer Payment
The calculation can be done as follows:
- PI = $1, 00,000 + $8,000 + $7,500 + $3,000 + $2,000
PI will be –
- PI = $1, 20,500
In this example, we will calculate the personal income of the United States of America as a whole by considering all the household members of the United States. Following are the data related to United States national accounts:
Use the given data for the calculation.
Calculation can be done as follows:
- PI = 8,500.00 + 1,350.00 + 700.00 + 1,550.00 + 2,800.00 + 1,518.00
PI will be –
- PI= 16,418.00
In example 3 we will calculate the personal income by adjusting the national income.
In this example following formula will be used to calculate personal income.
PI = National Income – Income Received But Not Earned + Income Earned But Not received
Calculation be done as follows:
- PI = 25,000.00 – 2,800.00 + 2,000.00 + 1,200.00 + 2,000.00 + 30.00 + 500.00
PI will be –
- PI = 16,470.00
Relevance and Use
- As already mentioned above that the personal income is among the three measures of income being reported by the Bureau of Economic Analysis. Disposal income and National income are the other two measures. Gross Domestic Product (GDP) and Net Domestic Product (NDP) are two interrelated measures of production.
- It is primarily used to measure the income being shell out to members of the household sector and provides the basis for consumption expenditure in the Gross domestic product (GDP) after adjusting income taxes.
This has been a guide to what is Personal Income and its definition. Here we discuss the formula to calculate personal income along with practical examples and downloadable excel template. You can learn more about financial analysis from the following articles –