How is residual income defined?

Residual income is defined as the income that exceeds the minimum required return on investment. This concept focuses on evaluating the profitability of a business or an investment by determining whether it is generating sufficient returns over a benchmark, which is usually the minimum rate of return expected by investors or the cost of capital.

The significance of calculating residual income lies in its ability to assess management performance. When a company generates residual income, it indicates that it has not only covered its costs and met the required return but also added value beyond this basic expectation. This makes it a useful metric for decision-making in resource allocation and performance evaluation.

In contrast, the other definitions do not capture the essence of residual income. Total income from investments might consider gross returns without accounting for the required benchmarks, while profit generated by operating activities focuses solely on the operational side without relating it to investment returns. Remaining income after all expenses are deducted does not specifically indicate the performance against a required return threshold, making it less relevant in evaluating the concept of residual income.