# Residual Income: What It Is, Types, and How to Make It

> **Definition**
>
> Residual income is ongoing earnings that continue after the initial investment is completed, and it's commonly from dividends, rental properties, royalties, or business ventures.

## What Is Residual Income?

Residual income is money that continues to come in after an initial investment of time, effort, or capital. Common sources include royalties, rental income, dividends, and interest payments. It's often associated with passive income, though the two aren’t always interchangeable.

Depending on context, “residual income” can also mean:

*   **In personal finance:** The [discretionary income](https://www.investopedia.com/ask/answers/040615/what-difference-between-residual-income-and-passive-income.asp) you have left after paying all monthly debts.
*   **In corporate finance:** A performance metric showing the profit remaining after covering the full cost of capital.  
    

### Key Takeaways

*   Residual income typically requires upfront work or capital, but minimal ongoing effort.
*   It’s often (though not always) referred to as passive income.
*   Sources of residual income include real estate investing, stocks, bonds, and royalties.
*   In a business context, it measures profitability after deducting the cost of capital.

  

![Visual representation of the concept of residual income with text displayed and decorative graphics](https://www.investopedia.com/thmb/uVtdXdrU0O7xgcWJQoc9E_YVERY=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Residualincome-Final-aa06a1d8e8c24cadb8fad5b3da5de6ae.jpg)

*Residual income provides an accurate assessment of the monetary value generated by an investment or business. — Investopedia / Michela Buttignol*

## How Residual Income Works 

At its core, residual income refers to what’s left after subtracting costs, whether those are operating costs, capital costs, or debt payments. Depending on how it's used, it can mean different things:

*   **In corporate finance**, it's the profit above the required return on capital.
*   **In investing**, it's used to estimate the intrinsic value of a company.
*   **In personal finance**, it’s what’s left after paying your bills each month.  
    

Other terms for residual income include [economic value-added](https://www.investopedia.com/articles/fundamental/03/031203.asp), [economic profit](https://www.investopedia.com/terms/e/economicprofit.asp), and abnormal earnings.

> **Important**
>
> Although residual income is sometimes known as passive income, side hustles can be used to boost personal residual income. 

## Types of Residual Income 

### Stock Valuation

Residual income is also a valuation method for estimating the intrinsic value of a company's common stock. It accounts for the [cost of capital](https://www.investopedia.com/terms/c/costofcapital.asp), meaning the combination of debt and equity expended to finance the company's operations.

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 in this case is the profit remaining after the deduction of [opportunity costs](https://www.investopedia.com/terms/o/opportunitycost.asp) for all sources of capital.

Residual income is calculated as [net income](https://www.investopedia.com/terms/n/netincome.asp) less a charge for the cost of capital. This is known as the equity charge and is calculated as the value of equity capital multiplied by the cost of equity or the required rate of return on equity.

The formula is:

**Residual Income = Net Income - Equity Charge**

Given the opportunity cost of equity, a company can have positive net income but negative residual income.

### Corporate Finance

Managerial accounting defines residual income for a company as the amount of leftover operating profit 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](https://www.investopedia.com/terms/r/requiredrateofreturn.asp).

Residual income in this case may be used to assess the performance of a capital investment, a team, a department, or a business unit.

The calculation of residual income is as follows:

**Residual income = operating income - (minimum required return x operating assets).**

### Personal Finance

In personal finance, residual income is synonymous with monthly [disposable income](https://www.investopedia.com/terms/d/disposableincome.asp). It is the total income that remains after paying all monthly debts.

Thus, residual income is often a key factor when a lender considers a loan application. An adequate amount of residual income indicates that the borrower can cover the monthly loan payment.

## How to Generate Residual Income

Most sources of residual income require an upfront investment of money, sweat equity, or both. Some examples:

*   **Buy bonds.** Once the [bonds](https://www.investopedia.com/terms/b/bond.asp) are purchased, the owner has a stream of cash available until the bonds reach their maturity.
*   **Buy a rental property.** Renting out a second home or [investment property](https://www.investopedia.com/terms/i/investment-property.asp) is a sound way to add to your income without much effort after the initial investment. If you lack the seed money, consider renting out a spare bedroom.
*   **Invest in index funds.** Your profits can grow over time even if you don't actively manage your investment.
*   **Peer-to-peer lending.** The Internet has opened the way to various types of residual income, including [peer-to-peer lending](https://www.investopedia.com/articles/investing/092315/7-best-peertopeer-lending-websites.asp). Many platforms are available to facilitate personal unsecured loans between individuals at competitive rates of interest.
*   **Sell your stuff.** In the broadest sense, residual income can be any side gig that adds to your income outside your regular job. eBay is good for cleaning out your closet and making money at the same time. Etsy is great for creative types who want to monetize a hobby.

## Residual Income vs. Passive Income

The differences are subtle. Residual income may be [passive income](https://www.investopedia.com/ask/answers/040615/what-difference-between-residual-income-and-passive-income.asp), but passive income isn't necessarily residual.

In personal finance, passive income may be derived from stock dividends or from renting a room on Airbnb. There was an initial outlay of money to buy the stocks or the house, but a tangential benefit that costs little in additional time or effort has been derived from the initial investment. It is residual income as well as passive income.

*   Passive income is earned with little or no effort required after the initial investment.
*   Residual income, for an individual, means the free cash available for spending after all obligations are met.

## Is Residual Income Taxable?

Yes, almost all residual income is taxable.Whether it’s dividends, rental income, or side gig earnings, residual income is typically taxable. Exceptions include income from certain tax-exempt municipal bonds.

## Why Is Residual Income Important?

Residual income is often passive income. Passive income is, by definition, relatively effortless. Stock dividends and bond premiums are examples. To quote legendary investor Warren Buffett: "If you don't find a way to make money while you sleep, you will work until you die."

## How Do I Calculate My Residual Income?

If you are applying for a loan, your residual income is the amount of money you have to spend after all of your monthly obligations have been paid. This is also called discretionary income.

If you are planning your long-term future, residual income takes on a different meaning. It is the amount of money you generate (or plan to generate in the future) from passive sources such as dividends and interest.

## The Bottom Line

Residual income is not free money. It takes planning, capital, or hard work up front. But once set up, it can provide ongoing earnings with minimal maintenance. Whether you're evaluating an investment, applying for a mortgage, or [planning for retirement](https://www.investopedia.com/articles/retirement/11/5-steps-to-retirement-plan.asp), understanding residual income is key to achieving financial freedom.