Incremental cost

INCREMENTAL cost refers to the additional expense a business incurs to produce one extra unit of a product or service. It is essentially the price tag on that extra unit, considering only the costs that change with the production increase. Incremental cost focuses on additional units as it isolates the expenses associated with making more things, not the overall cost of production.

Not all costs are relevant to incremental cost calculation. Fixed costs, like rent or salaries, remain the same regardless of production volume. Incremental cost mainly considers variable costs, which fluctuate with production changes, like raw materials or direct labour.

Why is incremental cost important? Businesses use incremental cost analysis to make informed decisions in various scenarios such as pricing products. By understanding the additional cost to produce another unit, businesses can determine a profitable selling price.

Incremental cost analysis helps assess if a new order with a lower price point is still worthwhile.

Considering the incremental costs of producing a new product helps decide if it will be financially viable. The formula for incremental cost is: Incremental cost = Total cost (producing additional units) - Total cost (original production). For example, if a company produces 100 widgets for a total cost of $1 000, and then produces 20 more widgets for a total cost of $1 100, the incremental cost to produce those extra 20 widgets would be $100. By comparing incremental cost with the incremental revenue (the additional income from selling those extra units), businesses can assess profitability and make strategic decisions.