Residual Income (What It Is And Why It’s Important)

What is Residual Income?

What is the goal of residual income?

How to find residual income?

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What Is Residual Income

Residual income is income that is generated even after the initial setup of the income source.

For example, if you start a blog to earn advertisement income from showing display ads or affiliate marketing income, you are effectively earning residual income as you continue receiving advertisement revenues even after you set up the blog.

In essence, once the initial work has been done to set up the income-producing asset, you are looking to assess how much money is left over to you once you have paid all the debts and costs associated with the income-producing source.

Typically, “residual income” is the amount of money that is left over once you have paid all the operating costs, expenses, debt obligations, and other costs.

For example, if you have a blog where you have to pay fees for hosting your website, you may have to pay for various premium plugins, or have other expenses associated with running and operating your blog, your residual income will be the amount of money that is left over after you paid your expenses.

For example, imagine that you incur the following costs to operate your blog:

  • Hosting fees: $500
  • Website maintenance: $500
  • Monthly subscription fees: $1,000

If your blog generates $5,000 per month, then you can say that you have a $3,000 residual monthly income.

In personal finance, residual income refers to a source of income that is generated from means other than the person’s main employment, salary, wages, or hourly work but rather from the investment of time or capital to generate an independent and steady stream of income.

Residual Income Definition

According to Investopedia, residual income is defined as follows:

Residual income is income that one continues to receive after the completion of the income-producing work. 
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As you can see from this definition, residual income can be characterized as:

  • For of income
  • That is generated 
  • Even after the initial effort for producing the income 

Residual Income Formula

There are several ways we can define residual income depending on whether you are looking at it from a personal finance perspective, corporate finance, or equity valuation.

In the context of personal finance, residual income is what an individual has in money left over after all his or her debts and expenses are paid to generate that income.

For example, a person may invest in a real estate property generating rental revenue on an ongoing basis.

The person’s monthly disposable income (residual income) is the monthly rental revenues minus the monthly debts such as mortgage payments, insurance, taxes, and so on.

In the context of corporate finance, the formula for residual income is:

Residual Income = Operating Income – (Operating Assets X Required Return)
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In other words, the profit leftover to the company from its revenues after deducting for the cost of capital used to generate the revenues is the company’s residual income.

In the context of equity valuation, residual income is used to estimate the intrinsic value of a company’s stocks.

In other words, it’s a measurement of a company’s economic profits by considering its economic earnings and deducting the opportunity costs for all sources of capital.

How To Calculate Residual Income

There are different ways of calculating residual income depending on whether you are looking at it from a personal finance point of view, corporate finance, or equity valuation.

The first application of residual finance is in personal finance where residual income refers to the money you have leftover from an investment source once you have paid your debt or financial obligations to maintain that income source.

The personal finance residual income formula is:

Residual Income = Monthly Net Income – Monthly Debts
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The second application of residual income is in corporate finance.

In this context, companies look to calculate residual income to better allocate their resources between different investment options.

Managerial accountants and businesses can use the following formula to calculate the corporate finance residual income:

Residual Income = Controllable Margin – Average Operating Assets X Required Rate of Return
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The third application is in equity valuation where residual income is used to estimate a company’s stock value.

Evaluation experts can use the following equity valuation residual income formula:

Residual Income = Net Income – Equity Chart
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Residual Income vs Passive Income

What is the difference between residual income and passive income?

Do they mean the same thing or are they different?

Although many use the terms “residual income” and “passive income” interchangeably, these two terms do not have the same meaning.

Residual income is more a calculation rather than a type of income as it is a measure of how much money is left or profit generated by the business once all its financial obligations are paid.

Typically, residual income is earned on an ongoing basis but it does not mean that it’s earned passively or without effort.

On the other hand, passive income is a type of income that is earned passively and without much effort on an ongoing basis.

To earn passive income, the investor or entrepreneur will need to spend time, money, and effort to set up the passive income-producing asset but once it’s up and running, cash flow is generated passively.

Passive income is attractive as it provides the owner or beneficiary with additional financial security as they receive a steady cash flow over time without having to dedicate themselves to that activity in a significant way.

Residual Income Examples And Ideas

There are many ways you can generate income residually or on an ongoing basis.

Here are a few examples of residual income that you can potentially generate:

  • Stock investment (dividend passive income)
  • Bond investment (interest income)
  • Royalties (from ebooks, photos, digital products, or software)
  • Affiliate marketing commission
  • Dropshipping income
  • Online course income 
  • YouTube video advertisement income 
  • Peer-to-peer lending 
  • Flip retail products 
  • Real estate investment trust 
  • Rental income 
  • Sale of informational products 
  • Online subscription business
  • Crowdfund real estate 
  • Create and license an app
  • High yield savings account 
  • Starting a blog 
  • Creating an online store (e-commerce)
  • Rent a room, apartment, or house 
  • Investment income 
  • Launch a podcast 

Individuals generating residual income (money earned from sources other than a person’s salary, wages, or hourly fee) can develop their net worth over time and achieve financial security and wealth.

Residual Income Meaning Takeaways 

So, what does residual income mean?

How do you calculate residual income?

What are some examples of creating residual income?

Let’s look at a summary of our findings.

Definition Residual Income

  • Residual income is money that is generated with an income-producing asset even after the income-producing work has been completed 
  • You can earn residual income through an initial investment of time or money (or both) 
  • In personal finance, residual income is generally considered to be passive income that you generate over time on a recurring basis (like rental revenues in real estate or affiliate marketing for online businesses)
  • In corporate finance, residual income is more of a measurement of performance or calculation as it represents the amount of money a company has leftover in a given period once all the costs for generating the revenues are taken into account (it’s the calculation of the company’s discretionary income once all expenses are paid)

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