Residual income is the income of an individual minus all debts and expenses.
These debts and expenses include mortgages, loans and other expenses and liabilities.
Residual income calculation is done usually on a monthly basis, and the monthly debts and expenses are subtracted during the calculation.
Residual income for companies is calculated by the management team to appraise the return which is above the company’s targeted return.
How residual income is calculated?
To break it down, residual income is the amount of money which is left after all costs of capital are paid for a certain period.
Residual income is, therefore, an important factor in both corporate finance and personal finance.
Here, we are going to take a look at how residual income is calculated for personal finances.
Residual income in personal finances: How is it calculated?
In the context of personal finance, residual income is nothing but an individual’s disposable income.
For instance, if somebody earns $20,000 every month with a tax rate of 35%, his net income would be $13,000.
If he has to pay a mortgage of $2000 every month and has to spend $2000 every month, his residual income would settle down at $9000.
Once the mortgage is paid entirely, his new residual income would go up to $11,000.
This is because he doesn’t have to pay $2000 every month toward his mortgage anymore.
As you can assume, residual income is an important factor for pre-qualification for a personal loan and for any other type of secured loan.
A lending institution would first look at your residual income and your credit score to determine your eligibility for getting a loan.
Your residual income suggests how much you have to spend every month for paying back your debts.
If you have enough residual income, you are likely to get qualified for a loan.
In fact, the lending institutions get a brief idea about the loan repayment capability of an individual by simply looking at his or her residual income and credit score.
Residual income in corporate finance
Apart from individuals, business entities also need to compute their residual income as they can see the ‘bigger picture’ by simply calculating their residual income.
Residual income is in fact the net income of a company, or the amount of profit which is above the targeted rate of ROI.
Residual income is assessed by business managers to appraise and evaluate the financial performance of a certain unit or the whole organization as a unit.
The calculation procedure at a glance
The calculation of residual income can be described in the following manner.
Residual income equals to the net operating revenue sans the cost of operating assets or the cost of capital.
By calculating residual income, business managers can easily evaluate the performance of different departments.
The department or vertical which has a higher residual income than the rest usually get more investment.
As an individual, if you want to calculate your residual income, you can approach a tax consultant or look at your bank statements closely to get an idea.