Residual income
Residual income is operating profit left after deducting a capital charge — the investment base multiplied by a minimum required return. A positive figure shows a unit earns more than its cost of capital.
Also known asRI
See it move
A waterfall chart opens at operating profit of €900,000, then deducts a single downward step — the capital charge of €600,000, computed as €6 million of invested capital multiplied by a required rate of 10 per cent — to arrive at residual income of €300,000. The chart shows that residual income is positive only when operating profit exceeds the cost of the capital deployed to earn it, distinguishing it from return on investment, which does not make this charge explicit.
The formula
Variables
- Residual income (€)
- Divisional operating profit (€)
- Required (minimum) rate of return set by the organisation (decimal)
- Investment base (assets employed by the division) (€)
Positive RI confirms the division has earned more than its cost of capital.