Residual Income Calculator

Residual Income Calculator

When analyzing a company’s profitability, traditional measures like net income don’t always provide the full picture. That’s where Residual Income (RI) comes in. Residual income considers not only the profit a company generates but also the cost of equity — the return required by shareholders. By subtracting the equity charge from net income, investors can determine whether a business is creating real value above and beyond its cost of capital.

Our Residual Income Calculator makes it easy to calculate both the equity charge and the residual income using just three inputs: equity capital, cost of equity (%), and net income. This tool is ideal for value investors, analysts, and corporate finance professionals who want to assess the sustainability of a company’s profits.

🔎 What is Residual Income?

Residual income is a measure of economic profit that accounts for the required return on shareholders’ equity. It is calculated as:

Where:
Equity Capital = Total shareholder equity invested in the business
Cost of Equity (%) = The expected return demanded by shareholders
Net Income = The profit after expenses and taxes

👉 Interpretation:
Positive Residual Income → The company is generating profits above shareholder expectations.
Zero Residual Income → The company is earning exactly the required return on equity.
Negative Residual Income → The company is failing to meet equity costs, signaling potential inefficiency.

📚 Step-by-Step Examples

Example 1

Equity Capital: $200,000
Cost of Equity: 12%
Net Income: $50,000

Step 1 – Calculate Equity Charge:

Step 2 – Calculate Residual Income:

✅ Equity Charge = $24,000
✅ Residual Income = $26,000
The company is creating extra value for shareholders, since residual income is strongly positive.

Example 2

Equity Capital: $150,000
Cost of Equity: 10%
Net Income: $15,000

Step 1 – Calculate Equity Charge:

Step 2 – Calculate Residual Income:

✅ Equity Charge = $15,000
✅ Residual Income = $0
Here, the company is only covering shareholder expectations. While not adding extra value, it is still delivering the required return.

Example 3

Equity Capital: $500,000
Cost of Equity: 14%
Net Income: $50,000

Step 1 – Calculate Equity Charge:

Step 2 – Calculate Residual Income:

✅ Equity Charge = $70,000
✅ Residual Income = −$20,000
This company is failing to meet shareholder expectations. Despite generating net income, its residual income is negative, suggesting poor use of capital.

✨ Key Features of the Residual Income Calculator

💡 Why Residual Income Matters for Investors

Goes Beyond Net Income: RI considers the cost of equity, unlike traditional accounting profits.
Helps Spot True Value: Companies with strong positive RI are genuinely creating wealth.
Reduces Risk of Overvaluation: Prevents over-reliance on net income without capital costs.
Supports Long-Term Investing: Encourages investments in businesses that sustain above-average returns.