If you’re like most people, you probably believe that financial freedom is reserved for a special few.
You know, the CEOs, high earners, and those with widely varying technological skills.
But the reality is that everyone is capable of building wealth and gaining the ability to make choices in life.
How? By creating a stream of residual income.
Contrary to popular belief, the size of your paycheck doesn’t determine your wealth.
Rather, wealth comes from your ability to support yourself should you lose your main income.
This is where earning residual income can set you down the path to accumulating wealth and achieving financial independence.
Not too familiar with this income type? No need to worry. In this post, we’ll break down everything you need to know about residual income.
Read on to learn what residual income is, how it differs from other incomes, and how you can earn it to start building real wealth.
What is residual income?
Residual income refers to the net income you earn after covering your expenses and debts.
You might have heard of discretionary income, which is money you can spend at your discretion. Residual income is the same thing.
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Most people get paid when they trade time for money, meaning there’s active work involved in generating that income.
But there are many residual income opportunities that can make you money with little effort on your part.
Talk about working smarter!
By creating streams of residual income, you can increase your wealth and gain control over your finances.
Why is residual income important?
Residual income is crucial for many reasons. For one, it provides a more accurate picture of your financial health than just your current income. This information is important for several parties.
For instance:
- When you apply for a loan, lenders consider your residual income to determine if you have enough income to cover additional loan payments.
- Student loan providers determine whether you’re a good candidate for income-driven repayment plans based on your residual income.
- Want to buy a new car or a second home? Your residual income will determine whether you can achieve your goal.
By understanding the importance of residual income and actively managing your finances, you can improve your financial health and work toward your objectives.
Types of residual income
Residual income can have different meanings in different contexts. Here’s a look at some of the common areas that make use of this income.
Corporate finance
Residual income is how you calculate profit in the world of corporate finance.
You can use it to identify a company’s net worth by subtracting the opportunity costs of capital from the annual operating profit.
And if you want to know the equity value of the company, you can use residual income to estimate the intrinsic value of its shares.
Personal finance
You can also use residual income to determine your creditworthiness.
Banks and other institutions often use this income to determine whether an individual is making enough to secure a loan and cover his expenses.
So if you’re left with a good chunk of money after settling all your debts and monthly payments, you can demonstrate your financial standing to get approved for a loan.
Online business
If you set up an online business, your residual income will be the profit you make after you put in the initial effort.
For example, you might open a Shopify store to sell profitable items. Getting the business up and running will require some effort and investment in the beginning. So you’ll subtract these items from the revenue you generate at the end of each month to get your residual income.
Typically, there’s very little work required to maintain the flow of income after the initial effort is made. Hence, in the context of online business, residual income is also referred to as passive income.
How to calculate residual income
To determine your residual income, you will need to use a formula that takes into account the average operating assets and net income from your investment or business.
Residual income formula:
Residual income = Net Income - (Average Operating Assets x Cost of Equity)
- Net income: Your total revenue minus all explicit and implicit costs, including taxes and interest payments.
- Average operating assets: The assets used in generating income for your business or investment, such as inventory, equipment, and property. To calculate the average operating assets, add the beginning and ending balance of your assets for the period you’re measuring and divide by two.
- Cost of equity: The return investors expect to earn from investing in your business or investment. It can be calculated using the capital asset pricing model (CAPM) or a similar model.
Here’s an example with numbers to help illustrate the calculation of residual income:
Let’s say you own a rental property that generates $30,000 in annual rental income. The expenses for the property, including property taxes, maintenance, and mortgage payments, total $25,000 per year. To calculate your net income or economic profit, subtract your expenses from your rental income:
$30,000 - $25,000 = $5,000 (net income)
Next, you need to calculate your cost of equity. Let’s assume your cost of equity is 10%. This means your investors expect to earn a 10% return on their investment in your rental property.
Now, you need to calculate your average operating assets. Let’s say the value of your property is $200,000, and you have $50,000 in other assets used to generate rental income. Your average operating assets would be:
Average Operating Assets = ($200,000 + $50,000) / 2 = $125,000
Finally, you can calculate your residual income:
Residual Income = $5,000 - ($125,000 x 10%) = $5,000 - $12,500 = -$7,500
In this example, your residual income is negative, which means you’re not earning enough to cover the cost of equity capital. You may need to adjust your rental property strategy, such as increasing rent or reducing expenses, to generate a positive net income.
Residual Income Vs Passive Income
If you search “residual income meaning” on Google, dozens of interpretations will pop up, with some suggesting that residual income is the same thing as passive income. And to some extent, this is true. The reason people often use “residual income” and “passive income” is because they make a residual while earning passively.
For example, a blog owner – let’s call him Tom – decides to earn passively. For this purpose, he inserts affiliate links in some of his posts. When visitors to his blog click on those links, he generates passive income. The commission Tom pays to his affiliate partner and the taxes he pays on his overall affiliate earnings are deducted to arrive at his residual income.
The main idea behind residual income is to account for the expenses involved in creating passive income streams.
Types of Residual Income
Residual income can have different meanings in different contexts. Here’s a look at some of the common areas that make use of this income.
Corporate finance
Residual income is how you calculate profit in the world of corporate finance.
You can use it to identify a company’s net worth by subtracting the opportunity costs of capital from the annual operating profit.
And if you want to know the equity value of the company, you can use residual income to estimate the instinct value of its shares.
For the purpose, you’ll assess the company based on the sum of its book value and the current value of its anticipated future residuals.
You can do this by subtracting net capital costs from net income. The figure you get will be the net profit after adjusting for the cost of equity.
Personal finance
You can also use residual income to determine your creditworthiness.
Banks and other institutions often use this income to determine whether an individual is making enough to secure a loan and cover his expenses.
So if you’re left with a good chunk of money after settling all your debts and monthly payments, you can demonstrate your financial standing to get approved for a loan.
Online business
If you set up an online business, your residual income will be the profit you make after you put in the initial effort.
For example, you might open a Shopify store to sell profitable items. Getting the business up and running will require some effort and investment in the beginning. So you’ll subtract these items from the revenue you generate at the end of each month to get your residual income.
Typically, there’s very little work required to maintain the flow of income after the initial effort is made. Hence, in the context of online business, residual income is also referred to as passive income.
How to Make Residual Income
Creating a residual income stream can be life-changing for everyone.
Whether you’re in college or well into your career, consider opportunities that enable you to earn recurring income down the road.
Here are residual income streams to get you started:
1. Start a dropshipping store
A dropshipping store is essentially an online store where people come to buy different items.
When a customer requests an item, the order goes to a third-party supplier who then ships the product directly to the customer.
This means you don’t have to worry about storing inventory or how to get the item to the customer.
Hence, running a dropshipping store can be one of your best sources of residual income.
With suppliers handling the major aspect of your operation, i.e. product fulfillment, you will have less active work like shipments and customer service.
To start, you can create an online store on Shopify. Once done, install the Automizely app so you can find dropshipping suppliers for your business.
2. Open a subscription business
This residual income business requires some upfront work to get off the ground, but execute it well, and you could sit back and watch the money in your bank account grow automatically.
From clothing to shaving items, there are a lot of products you can sell through a subscription business.
And you can hire a fulfillment house to package and send out your products and subscription boxes for you.
Companies like Cratejoy can also handle the process of onboarding new customers, so there’s minimum work involved once the business starts running.
3. Rent out your property
As remote work has become a hot trend, you may not be using your home or apartment as much as you normally would.
Instead of letting it sit empty, create a residual income stream from it by listing it on Airbnb or a similar platform.
Even renting a spare room can generate discretionary income if you don’t want to rent your entire property upfront.
A tip for being successful with this strategy is to keep your tenants happy.
Far too many landlords fall into the negative stereotype of being greedy, neglecting concerns and issues, and generally ignoring the expectations for amenities.
To be the landlord everyone likes (and refers), check in with your renters daily and address any inconveniences at the earliest opportunity.
4. Crowdfund real estate
Real estate crowdfunding relies on small investments from several people to purchase property or fund real estate development.
You can sign up to be one of the investors and make easy residual income. Websites like Fundrise and RealCrowd allow people to pitch in at different investment tiers.
As soon as your investment is processed, you become an equity shareholder in a real estate venture and start earning passively through regular dividend payout.
You may also benefit from property appreciation over time. When the assets owned by the investors go up in value, dividend earnings also rise.
To start, make sure to sign up with a few real estate crowdfunding websites. Having access to multiple sites means you should be able to access four to eight new property deals every month, more than enough to be picky with your investments.
5. Create an app
If you possess some technical skills, making an app can be a great way to leverage your existing knowledge to earn some residual income.
You could put together an expense tracking app, a news app, a to-do list app, or a recipes app, depending on what people would find useful.
Or if you have an idea for a gaming app like PUBG, give it a shot. It could be the key to a large fortune.
If you don’t know how to code but have a great idea for an app, consider hiring developers and coders from Upwork or PeoplePerHour.
Once you’ve hired someone and built your app, you can earn residual income through advertising, paid access, and add-ons that users can purchase to make the app more enjoyable.
6. Publish a book
This is one of the best ways to make residual income.
Whether you opt for the services of a traditional publisher or self-publish through print-on-demand services, publishing a book is a really smart financial move.
Earnings will continue to roll in through royalties and purchases, and there’s also the chance to make thousands should the book go on to become a bestseller.
The best way to start this is with a plan, rather than penning away whatever comes to your mind.
That is, consider what you’re passionate about or skilled at when brainstorming a title for the book.
It’s also a good idea to evaluate if the information you intend to share will be just as relevant five to 10 years from now. This will help ensure that people keep buying your book.
7. Sell photos
Are you good with a camera? Do you like taking candid shots of people in public places? Consider selling your work on websites like Getty Images or Shutterstock.
Tons of websites need to use stock images every day in blog posts and social media—and their owners are willing to pay for the right to use them.
Then why not sell rights to your collection of images? You can potentially license a set of photographs and sell them over and over with minimal effort after the initial upload.
All the logistics of image sales are managed by the platform you use to sell your photos.
8. Sell digital products on Etsy
Etsy has an Instant Download page where you can sell all kinds of digital products. These are items you deliver electronically rather than physically.
You can sell anything from anniversary or graduation cards to wall prints, inspirational text, or digital copies of your artwork.
The obvious benefit of this is that once you’ve created the digital file, you can sell multiple copies of it by listing it on the platform.
Plus, selling digital products has less overhead, as you don’t need to pack or ship anything.
9. Build an Instagram following
Naturally, this requires some upfront work. But once you build a loyal fan base, making residual income becomes easy.
To begin, create an Instagram profile and start posting content for a specific niche. And while you’re at it, use Instagram hashtags to get your posts in front of a wider audience.
While you may not be able to gain a following like any of the top Instagram stars, there’s plenty to be made from running a smaller Instagram account focused on a niche.
Businesses within your niche will consider the people you attract to be valuable to them, since they’re likely targeting a similar audience. And that could result in a decent-sized payout for you if they choose to sponsor your content.
Start earning residual income today
Everyone likes the idea of making additional income, but not everyone is able to create a secondary income stream. This might be due to a lack of strategy or genuine advice.
With these residual income ideas, you should be able to earn more income and typically do so passively.
These methods are easy to integrate into what you are currently doing. So you can start building wealth alongside your 9-to-5 job or another primary income source.
What are your favorite ways to make residual income? Let us know in the comments below.
Residual income FAQ
What is the difference between personal and corporate residual income?
Personal residual income is the income individuals earn via passive sources, such as rental income or stock dividends. Corporate residual income, on the other hand, is the income businesses earn via ongoing operations after deducting all expenses, including the cost of equity capital.
What is the difference between residual and passive income?
If you search “residual income meaning” on Google, dozens of interpretations will pop up, with some suggesting that residual income is the same thing as passive income. And to some extent, this is true. The reason people often use “residual income” and “passive income” is because they make a residual while earning passively.
For example, a blog owner—let’s call him Tom—decides to earn passively. For this purpose, he inserts affiliate links in some of his posts. When visitors to his blog click on those links, he generates passive income. The commission Tom pays to his affiliate partner and the taxes he pays on his overall affiliate earnings are deducted to arrive at his residual income.
The main idea behind residual income is to account for the expenses involved in creating passive income streams.
Can residual income be negative?
Yes, residual income can be negative. This occurs when the expenses associated with generating income from an investment or business exceed the income generated. In this case, the residual income is negative, indicating a loss on the investment or business operation.
On the other hand, when income generated exceeds the expenses, residual income is positive. Positive residual income indicates profitability and can be used to reinvest in the business, pay off debt, or invest in other income-generating opportunities.
