Loading the player...

What is 'Residual Income'

Residual income is the amount of income that an individual has after all personal debts and expenses, including a mortgage, have been paid. This calculation is usually made on a monthly basis, after the monthly debts are paid.

Additionally, residual income is used by a company's management team to measure the return generated above the company's minimum required return.

BREAKING DOWN 'Residual Income'

Residual income, at its highest level, measures the amount of money that's left over after all required costs of capital have been paid for the period being analyzed. Therefore, residual income is used in personal finance and corporate finance.

Residual Income for Personal Finances

Personal residual income is also known as a person's disposable income. For example, if a person earns $10,000 a month at a 35% tax rate, his take-home earnings before factoring in debt or expenses would be $6,500. If he has a monthly mortgage payment of $1,000 and $1,000 in other expenses, his residual income would be $4,500. Then, when the mortgage has been paid off in its entirety, the $1,000 that he had been putting toward the mortgage also becomes part of residual income, making the new residual income number $5,500.

Residual income is therefore often an important component of securing a loan. A loaning institution usually assesses the amount of residual income an individual has left after paying off other debts each month. If the individual requesting the loan has sufficient residual income to take on additional debt, the loaning institution is more likely to grant the loan. Having an adequate amount of residual income will ensure that the borrower has sufficient funds to make the loan payment each month.

Residual Income for Corporate Finance

Managerial accounting defines residual income in a corporate setting as the amount of operating revenues left over after all costs of capital used to generate the revenues have been paid. It is also considered to be the company's net operating income, or the amount of profits that exceed its required rate of return. Residual income is normally used to assess the performance of a department or a business unit.

The calculation of residual income is as follows: Residual income = net operating income - (cost of capital * cost of operating assets). This equation is essentially used as a measurement of opportunity cost, based on the trade-offs of investing in one department versus another department. The business unit that has a higher residual income gets more company investments.

RELATED TERMS
  1. Residual Dividend

    The term residual dividend refers to a method of calculating ...
  2. Residual Standard Deviation

    A statistical term used to describe the standard deviation of ...
  3. Solow Residual

    A measure of the empirical productivity growth in an industry ...
  4. Appraisal Ratio

    A ratio used to measure the quality of a fund's investment picking ...
  5. Abnormal Earnings Valuation Model

    A method for determining a company's worth that is based on book ...
  6. Target Payout Ratio

    A target payout ratio is a measure of what size a company's dividends ...
Related Articles
  1. Investing

    Explaining Residual Value

    Residual value is a measurement of how much a fixed asset is worth at the end of its lease, or at the end of its useful life.
  2. Financial Advisor

    Active Risk vs. Residual Risk: Differences and Examples

    Active risk and residual risk are common risk measurements in portfolio management. This article discusses them, their calculations and their main differences.
  3. Managing Wealth

    Learn The Lingo Of Private Equity Investing

    Once, only sophisticated investors worried about the private equity industry. But now, mainstream investors are developing an interest as well.
  4. Financial Advisor

    Is Texas Instruments a Good Value Play? (TXN)

    Find out whether investors and analysts believe that Texas Instruments would make a good value play at its current valuation, and learn more about its outlook.
  5. Investing

    Residual Income

    Discover why this simple calculation can determine whether or not you are eligibe for a loan.
  6. Personal Finance

    Reduce Interest With An All-In-One Mortgage

    "Offset" mortgages combine a checking account, home-equity loan and mortgage into one account.
  7. Personal Finance

    How to Use a Mortgage Calculator to Save Time and Money

    Calculate your monthly mortgage payment using the Investopedia's free calculator.
  8. Investing

    Financial Institutions: Stretched Too Thin?

    Find out how to evaluate a firm's loan portfolio to determine its financial health.
  9. Personal Finance

    When Are You Too Old for a Mortgage?

    The answer to that question is a personal one, as long as your finances qualify you for a home loan. Here are the factors to consider.
RELATED FAQS
  1. Is residual income considered profit?

    Understand what residual income is and under what circumstances it may be considered profit. Learn how this can benefit personal ... Read Answer >>
  2. What is the best app to track my residual income?

    Learn about apps that help you manage and track your residual income whether you have complex portfolios with multiple investments ... Read Answer >>
  3. How is residual value of an asset determined?

    Understand what the residual value of an asset is and how the residual value of an asset is calculated. Learn how residual ... Read Answer >>
  4. What does residual value represent in a private equity investment?

    Find out why private equity investors, particularly limited partners, are so concerned with the residual value of a fund's ... Read Answer >>
Hot Definitions
  1. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  2. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  3. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  4. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  5. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
  6. Dilution

    A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur ...
Trading Center