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Disposable Income: Meaning and Formula

Understanding what disposable income is necessary for everyone due to its functionality as a benefactor of personal financial management, notably for business finance. By properly understanding the concept and the formula for disposable income, entrepreneurs can gain a better understanding of their business’s financial position.

Quoting from the Corporate Finance Institute, the notion of disposable income is the result of the reduction between personal income and direct taxes. Disposable Income is the money that is available from an individual’s salary after they pay local, state, and federal taxes. The term is also familiar as disposable personal income or net pay. The net pay of a household includes earnings plus unemployment benefits and capital income.

One of the major determinants influencing consumer spending is disposable income. It is also a major factor in determining demand. The definition “disposable income” refers to the number of purchasable goods and services at various prices over a specified time period. This implies that an individual’s net pay has an impact on the amount of money they spent on products and services.

Annually, the number of net pay increases. This comes as an indicator that an increasing amount of spendable money for daily necessities. Logically, this situation brings the possibility of an increase in consumer purchasing power as well. As a result, this increase has an effect on both the production and the workforce of a business. By using the CRM-Sales System, company can easily track their productivity and maintain healthy cashflow. This way, the economy can grow and the unemployment rate might very well decrease, while household income may achieve better.

Table of Content

Calculating Disposable Income

To better understand what disposable income is, here’s what you should do to get the results of calculating it within a span of one year:

Disposable income formula:

Disposable Income = Personal Income – Personal Income Taxes

Indicators and examples:

  1. Disposable income is the residual income after deducting direct taxes and other dependents.
  2. Gross annual income (personal income) is all income in one year.
  3. Direct taxes and other deductions such as local, state, and federal taxes are annual taxes.

Suppose a family’s aggregate income is $150,000, along with an effective tax rate of 27%. The net pay for the family will be $109,500 [$150,000 – (27% x $150,000)]

Factors Affecting Disposable Income

Once you acknowledge how to calculate the net pay, it will become clear that it is affected by two major variables: direct taxes and nominal income. Thus, if the tax rate is decreasing or nominal income is increasing, net pay will automatically increase as well. For example, when a government pursues an expansionary fiscal policy, which decreases the tax rate, the remaining nominal income will automatically increase along with the budget for needs.

Because the large amount of net pay that exists also means that the individual or business has the ability to meet other necessities, such as saving and investing, as well as to fulfill other needs. Thus, it comes to the conclusion that an individual’s or company’s life will be way more secure in the long run.

Also read: What is Economic Goods and Their Differences with Free Goods

The Purpose of Disposable Income

The use of net pay as a measure of the financial health of a person or a business is common in the economic world. The way to measure financial health through this factor is to see how much disposable income a person or company has.

Because the large amount of net pay that exists also means the ability of the individual or business to fulfill other needs, including savings and investment. The conclusion is that the individual or the company will be stable in the long term.

Disposable Income and Discretionary Income: How Are They Different?

Disposable income

When you as a taxpayer receive income, your main allocation of funds is direct tax payments. After paying taxes, you will have leftover money which will later be used to fulfill irreplaceable basic needs. The net pay is where the money for needs such as home mortgages, and education insurance comes from.

However, not 100% of the net pay is available to use. It turns out that there is a derivative of disposable income called discretionary income. This means you could only use the remaining money after all basic needs are met. The use of discretionary income is usually for hobbies and entertainment or even saving and investing.

Tips on Managing Disposable Income

To achieve financial health, a person or a company must manage the residual income optimally. In order to maximize the management of net pay, there are several tips that can be applied:

Make an expenses priority list

Make sure you have a list of the un-diverted basic expenses from your household income. After calculating the net pay, you have to make sure that you have checked each item from the list. Such as water bills, electricity, insurance, or employee salaries in businesses.

Once you’ve met all of your basic needs, you’ll be able to set aside funds for discretionary income. The money set aside for discretionary income must be free of basic needs liabilities, as the primary objective is to pay off each item on the list of basic needs.

As a company with a lot of needs, it will be difficult to control purchasing priorities. Therefore, you can use a purchasing management system to control your procurement cost efficiently with budgeting and cost center per department or project.

Limit the budget for the disposable income

The distribution of income will certainly be different for each individual, and for each company for various reasons. That way, it is the lifestyle that is very influential in managing net pay.

Individuals and companies who are aware of their lifestyles will be able to manage their net pay more optimally. For example, each household or company does not have the same number of heads, nor the same habits. Such a thing is that it takes out of its net pay differently because everyone has a need.

Conclusion enterprenur

Many taxpayers neglect the importance of understanding what disposable is. While actually, the knowledge could help them achieve a successful financial experience. Not only for individuals but the knowledge about it is beneficial for corporate economics as well.

In managing income and expenses at a company, it is advisable to only use net pay funds with clear purposes and also for the irreplaceable basic needs. Taking control of your company’s expenses could be easier by using the best Accounting Software from HashMicro, optimizing the use of every fund you have with an accounting system that you can customize as needed.

Interest in getting savvy tips for improving your business efficiency?

Adellia
Adellia
A Junior Content Writer at HashMicro who treasures the feeling of exhilaration in discovering new ideas as the put out of the things I read and see. For business inquiries: [email protected]

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