Residual Income – Types, How to Make It [Residual Income vs. Passive Income]

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Written By
Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.
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What Is Residual Income?

Residual income is defined as revenue that continues to be generated after the initial effort has been expended. This can include interest payments, dividends, and royalties.

Essentially, residual income is money that is being earned without having to put in active work.

 

Types of Residual Income

There are different types of residual income streams, but the most common are royalties, dividends, and interest payments.

Each of these three types of residual income has its own unique characteristics.

Royalties

Royalties are payments made to an individual for the use of their intellectual property, such as patents or copyrights.

These payments are typically based on a percentage of sales or a fixed rate per unit sold.

Dividends

Dividends are periodic payments that a company makes to its shareholders out of its profits.

Dividends are usually paid quarterly, but can also be paid monthly or annually.

Related: Complete Guide to Dividend Income

Interest payments

Interest payments are periodic payments that a lender makes to a borrower for the use of their money.

Interest payments are typically made monthly, but can also be made quarterly or annually, with the return often called the APY.

 

How to Make Residual Income?

There are a few different ways to generate residual income streams. The most common way, as mentioned above, is through royalties, dividends, and interest payments.

Royalties can be generated by owning patents or copyrights to products or ideas that are then licensed out to others for use.

For example, if someone writes a book and sells it, they’ll make money from it as long as it continues to sell.

If someone has music that they copyrighted, they can make money from it as long as people continue to buy and listen to it.

Dividends can be generated by owning shares of stock in a company that pays dividends.

For example, if someone owns 100 shares of stock in a company that pays a quarterly dividend of $1 per share, they will receive $100 in dividends every quarter.

Interest payments can be generated by lending money to individuals or businesses.

For example, if someone has $10,000 to lend, they could lend it out at an interest rate of 10%, and would then receive $1,000 in interest payments every year.

 

Residual Income vs. Passive Income

Residual income is often used in the same sense as passive income.

Passive income is defined as income that does not require active work to generate.

Residual income, on the other hand, is defined as revenue that continues to be generated after the initial effort has been expended.

In other words, passive income is generated with little to no effort, while residual income may (or may not) require some level of ongoing work.

In essence, they often do mean the same thing.

Passive income has basically taken over as the term of choice whereas few use the term residual income to refer to the types of activities that are almost universally known as passive income.

But most of what people call “passive income” is basically the same thing as residual income.

Unless you are given assets with no work put in, income is very rarely truly passive.

You will need to work at something and then eventually live off the income stream.

For most, this involves:

  • selling their time in exchange for a salary, part of which they save, which…
  • goes into buying various types of investments, which…
  • produce an income stream, which…
  • they can eventually replace their working income with (perhaps to retire)

Related:

 

Residual Income in Corporate Finance

Managerial accounting defines residual income as the amount of operating profit that is left over after paying all costs of capital used to generate the revenues.

It is also considered the company’s net operating income or the amount of profit that exceeds its required rate of return.

Residual income is normally used to assess the performance of a capital investment, team, department, or business unit.

How to Calculate Residual Income

 

Residual Income in Personal Finance

Residual income is typically considered the amount of one’s disposable income, which is the amount of income one has after paying all their necessary expenses.

In other words, it’s what’s left over after you’ve paid your debts, set aside some money for savings and invested for retirement.

Lenders will often look at residual income to see how much cash flow is available to pay extra debts.

 

Residual Income in Investment Banking

In investment banking, residual income represents an economic earnings stream and valuation method for estimating the intrinsic value of a company’s common stock.

The residual income valuation model values a company as the sum of book value and the present value of expected future residual income.

Residual income attempts to measure economic profit, which is the profit remaining after the deduction of opportunity costs for all sources of capital.

 

How to Generate Residual Income

Residual income can be generated in a number of ways, including:

  • Dividends from stocks or mutual funds
  • Rental income from real estate investments
  • Interest payments from bonds or other investments
  • Royalties from patents, copyrights, or other intellectual property
  • Commissions from sales of products or services
  • Revenue sharing from business partnerships

One way to do this is to invest in assets that will generate passive income.

This could include things like:

  • Rental properties
  • Dividend stocks
  • Peer-to-peer lending
  • Royalty streaming
  • Etc.

Another way to generate residual income is to start a business that requires little to no upfront investment, but has the potential to generate a significant amount of passive income over time.

Some examples of businesses that could do this include:

  • Network marketing or direct sales
  • Drop shipping businesses
  • Affiliate marketing
  • Advertising
  • Subscription services

 

FAQs – Residual Income

Why Is Residual Income Important?

Residual income is a key metric when it comes to evaluating the financial performance of investments, businesses or projects.

It allows you to compare the expected return of an investment to the actual return that was generated.

In essence, it tells you how much “bang for your buck” you are getting.

When Should I Use Residual Income?

There are a number of different situations in which residual income may be useful:

When making investment decisions – Residual income can be a helpful metric when deciding whether or not to invest in a particular stock, bond or other security.

When evaluating the financial performance of a business – Residual income can be used to assess the profitability of a business or project.

When making decisions about pricing – Residual income can be helpful in determining the price of a product or service.

When considering issuing debt – Residual income can be used to evaluate whether or not a company has the ability to make interest payments on its debt.

What Are Some Disadvantages of Using Residual Income?

While residual income is a useful metric, there are some disadvantages associated with using it:

It can be difficult to calculate – There are a number of different factors that can affect residual income, which makes it hard to calculate.

It may not be representative of all cash flows – Residual income only considers one type of cash flow (recurring income) when there are other types of cash flows that could also be considered (e.g. one-time income).

It can be misleading – Residual income can sometimes give the false impression that a company or investment is more profitable than it actually is.

How Do I Calculate My Residual Income?

Your residual income, as commonly defined by lenders and in personal finance, is your disposable income.

This is the amount of money you have after you’ve paid all your necessary expenses, including debts, savings and investments for retirement.

To calculate your residual income, simply subtract your monthly expenses from your monthly income.

What Is a Good Residual Income?

A good residual income is one that covers all your necessary expenses and leaves you with enough money to live comfortably.

Ideally, you should aim to have a residual income that is at least equal to your monthly expenses.

This will ensure that you can cover your costs of living and still have enough money left over to save or invest for the future.

What Are Some Ways to Generate Residual Income?

There are a number of different ways to generate residual income:

Investing in assets that generate passive income – This could include things like rental properties, dividend stocks, peer-to-peer lending, and royalty streaming.

Starting a business that has the potential to generate passive income over time – Some examples of businesses that could do this include network marketing, drop shipping businesses, affiliate marketing, and subscription services.

How Do I Calculate Residual Income for Company Valuation Purposes?

Residual income is calculated by subtracting net income from net capital.

Net income is defined as total revenue minus total expenses.

Total revenue includes both operating and non-operating income.

Operating income is generated by the company’s core business operations.

Non-operating income includes interest, dividends, and other sources of income.

Total expenses include both operating and non-operating expenses.

Operating expenses are incurred by the company’s core business operations.

Non-operating expenses include interest, taxes, and other types of expenses.

What Is the Difference Between Residual Income and Passive Income?

They are basically the same.

Residual income is generated from an investment or business that does not require active participation from the investor or entrepreneur.

Passive income is generated from an investment or business that requires little to no effort from the investor or entrepreneur.

Residual income can be generated from a number of different sources, including investments in stocks, bonds, and real estate.

Passive income can also be generated from a number of different sources, but typically comes from things like royalties and other items on this list.

What Are Some Examples of Residual Income?

Some examples of residual income include dividends from stocks, interest payments from bonds, and rental income from real estate.

Residual income can also come from royalties received for the use of intellectual property, such as patents, copyrights, and trademarks.

What Are Some Examples of Passive Income?

Some examples of passive income include interest payments from savings accounts and bonds, rental income from properties, royalties from patents and copyrights, and income from dividend stocks.

Passive income can also come from business ventures in which the investor or entrepreneur does not need to be actively involved in the business in order for it to generate income.

 

Conclusion – Residual Income

Residual income is generated from an investment or business that does not require active participation from the investor or entrepreneur.

Passive income, on the other hand, is generated from an investment or business that requires little to no effort from the investor or entrepreneur.

Itt’s important to note that while residual income can be generated from a number of different sources, not all residual income streams are created equal.

Different types of residual income stream may have different levels of risk and potential return.

As such, it’s important to choose a residual income stream that aligns with your investment goals and risk tolerance.