Residual income
In one sentenceAn investment center's profit after subtracting the minimum required return on the funds invested in it; it shows whether it added profit above what was required.
Simply put
Management sets a minimum required return on funds, then subtracts it from the branch's profit. What remains is residual income.
Its advantage over a return ratio is that it is an amount in SAR, so it encourages the manager to make any investment that earns more than the minimum.
Worked example
A branch with a profit of 300,000 SAR and assets invested of 2,000,000 SAR, with a minimum required return of 12% (an assumed rate for illustration).
Minimum required return2,000,000 × 12% = 240,000 SAR
Branch profit300,000 SAR
Residual income300,000 − 240,000 = 60,000 SAR
Formula: Center profit − (assets invested × required rate of return)
Don't confuse it with
Economic value addedThe same idea, but economic value added uses after-tax profit and the actual cost of capital.