Incremental revenue is the additional revenue that is gained from increasing product sales by one unit. Essentially, it’s the additional total revenue that a company earns from producing and selling one more unit of a product. Incremental revenue is a key concept in managerial accounting and economics, where it is used to analyze the potential profits and costs associated with scaling up production or expanding into new markets.
Let’s take an example:
If a company is selling 100 units of a product at $20 each, the total revenue is $2,000. If by selling an additional unit (101 units), the total revenue increases to $2,020, the incremental revenue for the extra unit sold is $20.
Understanding incremental revenue helps a company in making production decisions. By comparing the incremental revenue (extra income from selling more) with the incremental cost (extra cost of producing more), a company can decide whether increasing production will be profitable.
Keep in mind, though, that incremental revenue may not always be constant. Due to factors such as economies of scale or price discounts for bulk purchases, the incremental revenue from selling an additional unit could vary.
Example of Incremental Revenue
Suppose a book publisher, “Bright Minds Publishing,” currently produces and sells 10,000 copies of a particular book per year. Each book sells for a price of $20, resulting in annual revenue of $200,000.
Now, Bright Minds is considering increasing its production by 1,000 books. The company wants to understand how much additional revenue this would generate.
If the selling price remains constant at $20, the additional revenue generated from selling 1,000 more books is:
1,000 books * $20/book = $20,000
So, the incremental revenue from producing and selling 1,000 additional books is $20,000.
This $20,000 represents the additional revenue that Bright Minds would gain by producing and selling an extra 1,000 books. However, in making a decision about whether to increase production, Bright Minds would also need to consider the incremental costs associated with producing 1,000 more books. If the incremental cost is less than the incremental revenue, it would be profitable to increase production.
Remember, this is a simplified example and assumes that the selling price and cost per unit remain constant, which might not be the case in a real-world scenario. For instance, producing and selling more books might lead to bulk discounts on raw materials or might require overtime work, both of which could affect the cost and revenue per unit.