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25 Nov 2019
What is residual income?

It’s important to know the meanings of the term, when to use it and how to take advantage of it. There are big misconceptions about what residual income means and where it’s used. Let’s firstly see where it’s used:

In the stock market, it’s used as a valuation method, where investors try to estimate the value of a stock and the potential of future profits. It represents the difference between net income and a charge of capital cost. For example, it’s possible to have the “net” above 0 but the “residual” below 0.
Companies use it to get a better understanding of the performance of different departments or investments. It’s defined as the result of operating profit minus the amount invested. An alternative calculus being the profit that exceeds the minimum rate of return.
Banks use it as a very important factor to decide if they approve the loan and the amount they lend. It’s like a security value that decides how much money can a borrower pay. It’s generally calculated on a monthly basis and it represents the amount of money the borrower has after he pays all his debts.

Now you know what is residual income, it’s not an actual income, but a term used for the amount that remains after every cost is deducted from the total income. Now, let’s see where it shouldn’t be used:

The single-time jobs, bets, or particular projects paid by hour are not included in the equation, because the goal of the time or money invested should make on-going revenue. Only salary or money from project-based jobs like consultants or any other service provider can be included when calculating residual income.
It’s not passive income. This misconception can be very damaging, so you need to understand the difference between them. Passive income can be generated from rental property, investment in stocks, royalties from patents, etc. Generally, the money made with little to no work is passive income. But most of them have costs or taxes. Only after you subtract those costs can the income be residual.

Why do need to manage it?

In personal finances, it’s not very important to calculate it. You should do it only in two situations. One, if you want to take a loan because it will help you determine your chances to loan the amount you want and if you can get a bigger one or if you should reduce it to increase your chances.

Two, if you have surplus money and you want to invest them. It will help you understand how much money you can invest every month and what amount you should expect to get in return.

You should keep in mind that, depending on your situation, it can become a very time consuming and complicated task. Sometimes is good to hire a professional or use a service provider and use that time to do a more important task.

For a company, it becomes almost mandatory to calculate it. The company will need it to understand the results they got, what to improve, what costs to reduce and how to increase efficiency. Once they go into the stock market it becomes a tool to attract investors. But it could also scare them, so it’s a very important aspect of the business.

After knowing what is residual income, do you think it’s important for you? Yes, then you should search for a provider that will help you. Or you could also delegate the job to an accountant. He will calculate your residual income and will take care of all your finances, but your cost will be equally higher. 


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