Nominal income and real income are both important concepts when it comes to judging the value or returns on business operations and investments. Individuals rarely need to show much interest in the difference between real and nominal unless the long-term returns from investments are a vital source of income. But businesses plan many of their activities based on the profits they expect from specific projects. Accountants and analysts often differentiate between nominal and real income to help study potential projects and give leaders a clearer idea of their effects.
Nominal income is essentially income as it shows up based on simple calculations, the income amount that can be counted on based on the preliminary analysis of a project. For instance, if $100,000 invested is expected to create returns of 3 percent, then the nominal income received from the investment will be $3,000, no strings attached. This makes viewing investment income and other future profits simple and easy for everyone involved to understand.
Many times managers are interested not in the numeric value of the return -- what it shows on paper as the profit made -- but in what the return will generate in terms of buying power, how useful the future returns will be based on what can be done with the money. If investments existed in a vacuum, then the nominal income amount would still work, but the income is actually influenced by many different economic motivators. These factors are taken into account to create a real income amount, a more practical amount of money that has real meaning in present-day analysis.
Two of the most important factors considered in real income are inflation and the general price of goods. Inflation refers to the value of money and how money can lose value over time as a process of a growing economy. A common inflation rate is around 3 percent value lost per year, but this can vary. The nominal income is decreased based on how many years ahead it is earned and what the expected rate of inflation is. The general price of goods also is calculated, since the price of goods can also rise in response to inflation and other market factors.
Managers and other business leaders are very interested in real income and how much it differs from nominal income when making decisions about financing projects. Businesses only have a certain amount of money to spend on projects and must choose those that offer the greatest returns. Real income is often a better example of present-day value of a project than nominal value, but knowing both can help a manager make wiser funding decisions.