Residual Income (RI)
Residual income is the amount of the money left over after the payment of all the necessary expenses and cost for a period. For the personal finance operations and for the corporate operation this calculation can be used.
Definition: What is Residual Income?
Personal Residual Income
Personal residual income is also known as discretionary income. It is the income or salary leftover after the debt payment such as a car loan payment for each month. By using the residual income calculator anyone can find out the salary leftover after debt payment. Personal residual income can be calculated by subtracting the monthly debt payment from monthly take-home pay.
Personal residual income = Monthly take-home pay – Monthly debt payment
In personal finance, this is an important concept because for loan affordability bank use this calculation. If RI is high then the chance of approval of the loan is greater. Low RI may make the cause of rejection of loan.
Business Residual Income
After the payment of operating expenses and costs, leftover amount of revenue fro department or investment center is called business residual income. In other words, the net operating income of department is called business residual income.
Residual income formula can be calculated by subtracting the product of the minimum required return and cost of operating assets from net operating income.
Residual Income = Net operating income – (Minimum required return x cost of operating assets)
Residual income from the above formula can be calculated easily. it shows that the company can meet its minimum or not. If RI is positive then the company make more then its minimum. If RI is negative then the company can’t make its minimum.
Residual income used by any time in conjunction with the return on investment ratio.
Tom has a furniture manufacturer company and makes tables. In the sawmill, there are large equipments. Sawmill’s net operating revenue for the year is 100,000 dollars. Cost of the saw in the mill is 500,000 dollars. In the table business of Tom, current earning a return of 10%. He set the 10 % minimum required a return.
Residual income of Tom calculated as
$50,000 = $100,000 – (10% x $500,000)
After the payment of the cost of capital, Tom has 50,000 dollars leftover. So his company making much more than the minimum requirement of 10 %.
For other capital expansion or investment, Tom can use this leftover amount.