Residual income measures how much operating income (or net income) is earned beyond management’s targets or goals. Residual income is a measure of profitability. Residual income is calculated as operating income minus a target income determined by management. Often the target income is based on a return on total assets. So we can expand the formula to be operating income minus a target rate of return times total assets. Here is an income statement from our sample company. We’ll use the highlighted operating income to determine the residual income. Of course this could be calculated using net income as well. Here is the balance sheet from our sample company. We’ll use the highlighted total assets in our calculations. For 2016, operating income minus target rate of return, which I’ve assumed to be 10% in this example, times total assets gives us a residual income of $7,870.
Residual income can be used for expansion and growth or to pay bonuses or dividends.