As a business owner, discretionary income is a term you should be familiar with. Small business growth depends on the amount of discretionary income your customers have at their disposal. But, what is discretionary income? How does it differ from disposable income, profit, revenue, cash flow, and other related terms?
While these terms may seem similar, there are a few key differences that separate them from one another.
Let’s take a look at what discretionary income is, why it’s important, and how you can calculate it.
What is Discretionary Income?
Discretionary income is the money you have leftover after accounting for taxes and personal necessities, including food, housing, etc.
In other words, discretionary income is the leftover income that is available to be used for saving, investing or spending on non-essentials. Non-essentials can include anything from eating out to taking a vacation.
As a business owner, it’s important to understand what is discretionary income, as it has a direct impact on the success of your company. During economic recessions, for example, small businesses tend to suffer as their customers don’t have as much discretionary income.
Discretionary Income vs. Disposable Income, Profits, Revenue, and Cash Flow
As mentioned, discretionary income is the money you have leftover after taxes and personal necessities. So, how does that differ from disposable income, profits, revenue, and cash flow?
- Disposable income and discretionary income are often used interchangeably but are not quite the same thing. Disposable income is your total personal income minus taxes. It can be used for both essential (like food) and non-essential expenses (like a vacation), unlike discretionary income.
- Revenue is the total amount of money your small business generates before any expenses are deducted. Revenue typically refers to money made from sales, but it can also include income from rental income, interest, and other sources.
- Profit is all of the revenue your business generates once all expenses have been paid for. Every dollar your business earns after paying for all expenses counts towards your business profit. There are three different types of profit: gross, net, and operating profit.
- Cash flow is the money that flows in and out of your business. Cash flow refers to the money your business has on hand at any given time. If you have positive cash flow, that means your business has enough cash on hand to cover all necessary business operations and expenses.
How to Calculate Your Discretionary Income
There are two ways you can calculate your discretionary income, and both are very simple.
Formula # 1: First, you can simply subtract your necessary expenses from your post-tax income. For example, if your take-home pay is $5,000 per month after taxes, and you have $2,500 in necessary expenses, your discretionary income would be $2,500 per month. This is the amount you are free to put in savings, invest, or spend on luxuries.
Formula # 2: Alternatively, you can calculate your discretionary income using the same method that the federal government and lenders use for the purpose of student loan repayment plans.
The U.S. Department of Education calculates discretionary income based on the poverty guidelines. Using this method, your discretionary income is your annual income minus 150% of the poverty guidelines for your family size.
For example, if your annual income is $60,000 and there are three people in your family, your discretionary income would be $28,005. Your monthly discretionary income would be this number divided by 12. In this case, it would be $2,333.75 per month.
How Does the Discretionary Income of Your Customers Affect You as a Business Owner?
Why does discretionary income matter to you as a business owner?
Small businesses that sell discretionary goods or services tend to suffer during economic recessions and financial crises. During these times, people don’t have as much money to spend on luxuries, making it difficult for small businesses to stay afloat.
By understanding this concept, you can take steps to attract customers during periods when discretionary spending is lower.
For example, say you run a hair salon. During a recession, your business would likely slow down as your regular customers don’t have enough discretionary income to get a haircut or a new hairstyle.
In order to encourage customers to come to your business, you could offer discounts. For instance, you can reduce your prices for families that come together. These types of promotions are great ways to encourage new business during times of crisis.
Tips to Make the Most of Your Discretionary Income as a Business Owner
How can you use your discretionary income to grow your small business? Let’s take a look at a few simple ways business owners can use their leftover income to encourage growth.
1. Pay Your Debt
Paying off your debt is a great way to utilize your discretionary income to help your business.
Once you have met your debt obligations and paid all of your business expenses, consider using some of your discretionary income to make additional loan payments.
Not only will this help you pay off your debt faster, but it will also save you money in interest and will increase your business’ cash flow.
2. Invest in Your Business
In order to grow your business, you need to invest in your business.
As a business owner, you can use some of your discretionary income to pursue new business ventures and help your company generate more revenue.
In addition to this, you should consider using a small business loan to invest in your business. Small business loans can be used for almost any purpose, from hiring personnel to buying equipment or making renovations. These loans are a great resource for small business owners in need of financing.
3. Save for Retirement
Lastly, you should consider using your discretionary income to start saving for your retirement.
As a small business owner, you may not have the same benefits package that you would have if you were an employee at a company. As such, you should take it upon yourself to start planning for retirement.
Discretionary income is an important concept for business owners to be familiar with. Not only does discretionary income affect consumer spending, but you should also know how to use your discretionary income to grow your business.
In order to maximize your income and help your business prosper, you should also consider using a small business loan to fund new business ventures.
Interested in learning more? Read: 20 Ways To Grow Your Business With A Loan.