PI can be made even while the person is asleep. The income stream is taxed differently in both cases - active and passive. Whereas passive income (PI) represents the money earned by an individual with little to no effort to obtain it. The key feature that changes both is that, by definition, it's an income that is not generated directly by a company.įrom this article, we understood the meaning of RI, which measures an individual's money left over after deducting expenses made from their overall income. Residual Income (RI) Vs Passive Income (PI)Īlthough both these terms look similar, in business and individual, they contain two different meanings. If an individual shows a high RI, his loan is more likely to be approved than an individual with a low RI. It is a prominent factor as it is one of the statistics used by banks before an individual's loan gets approved.īanks use this value to determine whether an individual has enough income from daily wages for an additional loan. It is known as disposable income or discretionary income. The RI is the process of planning and managing personal financial activities. It often becomes related to securing a loan as the lending firm assesses the RI remaining after paying each month's debts, and the approval of the loan should be more significant. In personal finance, it refers to an individual receiving excess income after paying all monthly debts such as mortgages and car loans. On the other hand, when it is a negative value, it has failed to meet the minimum rate of return. When it is a positive value, it means the company exceeds its minimum rate of return. It is usually utilized to assess the performance of the business unit, department, team, or even capital investment. It is also considered the company's net operating income or the amount of profit exceeding its required return rate. In corporate finance, it is calculated as the operating profit amount after paying all capital costs used to generate the revenues. Also, the company can have a positive income with a negative RI, given the opportunity cost. It is the net profit that's been calculated as the value of the company's equity capital multiplied by the cost of equity. The formula for calculating it in equity valuation is as follows: It measures the economic profit, which is the profit remaining after deducting the opportunity cost for all sources of capital. In such a way, the company is valued on the sum of its book value and the present value of the expected future RI. In equity valuation, RI is the money that a company regularly generates for estimating the intrinsic value of the company's share/stock. In this article, we shall delve into three types of residual income. Therefore, he can use his excess earnings to fund an expansion, pay debts, or distribute dividends to investors. This means Anas has a remaining net income of $25,000 after the capital cost has been deducted and also explains that his (F&V) shop is earning more than the minimum 10% required.Īnas effectively manages his income and expenses leaving additional income at the end of every month.

Meaning of residual income