Incremental Cost

Loading the player...

What is 'Incremental Cost'

Incremental cost, also referred to as marginal cost, is the encompassing change a company experiences within its balance sheet or income statement due to the production and sale of one additional unit of production. It is calculated by analyzing the additional charges incurred based on the change in a certain activity.

BREAKING DOWN 'Incremental Cost'

This activity, for example, may be production levels, sales, machine hours or area dimension. As the activity increases or decreases, the resulting change in the related expense is the incremental cost. For example, if production increased from 9,000 units to 10,000 units and the associated costs increased from $45,000 to $50,000, the incremental cost for the additional 1,000 units is $5,000.

Usefulness of Incremental Costs

Incremental costs are relevant in making short-term decisions or choosing between two alternatives. This includes whether to accept a special order. If a special price is established for a special contract, it is critical the revenue received from the special order at least covers the incremental costs or the special order results in a net loss. Incremental costs are also useful for decisions on whether to manufacture or purchase a good. Only the additional costs associated with the manufacturing of the good should be considered and compared to the retail price.

Unprofitable Business Segment

Incremental cost analysis is utilized to analyze business segments. Certain costs, such as the rent on an office building, are fixed and not attributable to any specific segment. Therefore, only the relevant incremental costs such as variable wages, utilities and materials must be considered in evaluating the profitability of a business segment.

Relevant Costs

Incremental costs are also called relevant costs because they encompass only the items necessary for analysis. All fixed costs are omitted from incremental cost analysis because they do not change. Therefore, fixed costs are sunk costs that should not be considered. Only variable costs such as materials or labor are considered in incremental costs.

Marginal Cost Equaling Marginal Revenue

Incremental costs help determine the profit maximization point for an organization. This point occurs when marginal costs equal marginal revenues. If a business is earning more marginal revenue per product than the incremental cost of manufacturing or buying that product, the business earns profit. Alternatively, once incremental costs exceed marginal revenue for a unit, the company takes a loss for each item produced. Therefore, knowing the incremental cost of additional units of production and comparing it to the selling price of these goods assists in maximizing profit.

RELATED TERMS
  1. Incremental Cost Of Capital

    A term used in capital budgeting, the incremental cost of capital ...
  2. Incremental Cash Flow

    The additional operating cash flow that an organization receives ...
  3. Operating Cost

    Expenses associated with the maintenance and administration of ...
  4. Production Cost

    A cost incurred by a business when manufacturing a good or producing ...
  5. Cost Accounting

    A type of accounting process that aims to capture a company's ...
  6. Marginal Cost Of Funds

    The incremental cost of borrowing more money to fund additional ...
Related Articles
  1. Investing

    What is Incremental Cost?

    Incremental cost is the added cost of manufacturing one more unit.
  2. Investing

    Understanding Incremental Cash Flow

    Incremental cash flow is the additional operating cash flow an organization expects to generate from a new project.
  3. Markets

    Understanding Marginal Analysis

    Marginal analysis is the process of comparing a one-unit incremental cost increase of an activity with a corresponding increase in benefits.
  4. Investing

    Contribution Margin

    Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products.
  5. Investing

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  6. Investing

    What are Fixed Costs?

    Fixed costs are business expenses that do not change as the level of production goes up or down. They are one of two types of business expense, the other being variable costs. Variable costs ...
  7. Investing

    The Gross Margin

    A business's "gross margin" is a rough gauge of how profitable its operations are. It measures how much sales revenue the company retains after all of the direct costs associated with making ...
  8. Investing

    Fundamental Analysis: The Income Statement

    By Ben McClureThe income statement is basically the first financial statement you will come across in an annual report or quarterly Securities And Exchange Commission (SEC) filing. It also contains ...
  9. Investing

    Explaining Cost Control

    For a business, cost control entails managing and reducing expenses.
  10. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
RELATED FAQS
  1. How are fixed costs treated in cost accounting?

    Learn how fixed costs and variable costs are used in cost accounting to help a company's management in budgeting and controlling ... Read Answer >>
  2. How do fixed and variable costs each affect the marginal cost of production?

    Learn about the marginal cost of production, how to calculate the marginal cost, and how fixed costs and variable costs affect ... Read Answer >>
  3. Do production costs include the marginal cost of production?

    Learn more about marginal costs of production and production costs. Find out how businesses can use marginal cost calculations ... Read Answer >>
  4. How is the marginal cost of production used to find an optimum production level?

    Understand more about production cost calculations, and specifically how the marginal cost of production is used to determine ... Read Answer >>
  5. Is it better for a company to have fixed or variable costs?

    Understand the difference between a fixed cost and a variable cost, and learn how a company benefits from having more fixed ... Read Answer >>
  6. How is direct cost margin calculated?

    Find out how to calculate the direct cost margin, including how it is used in corporate finance as an indicator of operational ... Read Answer >>
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center