How Do I Make Residual Income?

Residual income refers to the profit obtained from the investment, after deducting the investment amount (or net asset occupation amount) of the investment income calculated at the specified (or expected) minimum rate of return. It is the portion of a department's operating profit that exceeds its expected minimum return. That is: residual income = sectoral marginal contribution-accrued compensation of sectoral assets = sectoral marginal contribution-sectoral assets × capital cost. The residual income index can reflect the relationship between input and output, can avoid standardism, and unite the interests of individual investment centers with the interests of the entire enterprise.

Residual income

The formula for calculating residual income is:

Residual income = profit-investment (or

It is a surplus attributable to the business owner calculated in accordance with generally accepted accounting principles (GAAP). From the perspective of the business owner, GAAP requires that the fees paid to other stakeholders (suppliers, creditors, employees, etc.) who have priority over shareholders be deducted from the income, and the accounting income is used to measure the income belonging to the owner. section.

It is a concept used in economics to describe the ability of a company to create value.

Residual income though

Often referred to as residual income or economic profit. The main input variable in the residual income valuation model is also residual income, both of which are based on accounting income. These seemingly identical concepts have different meanings in different applications. Therefore, the determination of these concepts is the basis for further discussion and analysis.

EVA is a new term for business management and financial accounting. However, the concept of EVA is not a new creation. Its idea is derived from residual income. To a certain extent, EVA can be said to be a new version of residual income (Makelainen, 1998). The residual income method can be traced back to Alfred Marshall (1890). Marshall proposed the concept of economic profit and believed that a company must truly compensate for its operating costs as well as its capital costs.

EVA is a specific form of residual income. An important feature of EVA is that it requires accounting adjustments. EVA believes that GAAP has distorted the company's investment and income situation, such as research and development costs (R & D), which was an investment of the company but was included in the cost of the company. Such projects should be adjusted to reflect the true situation of performance. According to Stern-Stuart's proposal, more than 150 accounting adjustments can be made (Eba, 2001). These accounting adjustments often involve both book value and accounting income, so EVA is claimed to reflect the economic profit of the enterprise. But it should also be noted that these adjustments are made on the basis of accounting data. The adjusted book value is not the current value of the invested capital, and the adjusted income may not necessarily represent the true income. Therefore, EVA and economics The understanding of economic profit is still different. In fact, it is a performance measure between economic profit and accounting income. Due to the complexity of accounting adjustments and the difficulty of obtaining consistency, a simple method is to not adjust the accounting rules, but only to replace the book value with the market price of capital. This form of residual income is called precise or modified EVA Revised EVA, REVA).