The main objective of incremental principle is maximization of profits or in other words to raise the profits in the business
General rule:
By increasing in the production, the total cost of the product raises and simultaneously profit also rises.
Practicality in the business:
How much extra we should produce to get the best profits and how much extra cost would be incurred for the extra production.
Incremental concept involves estimating the impact of decision alternatives on costs and revenues, emphasizing the changes in total cost and total revenue resulting from changes in prices, products, procedures, investments or whatever else may be at stake in the decisions. The two basic components of incremental reasoning are:
Incremental cost
Incremental revenue.
Incremental cost may be defined as the change in total cost resulting from a particular decision. Incremental revenue is the change in total revenue resulting from a particular decision.
The incremental principle may be stated as follows: A decision is a profitable one if—
it increases revenue more than cost
it decreases some costs to a greater extent than it increases others
it increases some revenues more than it decreases others and
it reduces cost more than revenues.
Suppose a firm gets an order that brings additional revenue of Rs 3,000. The cost of production from this order is:
Rs.
Labour 800
Materials 1,300
Overheads 1,000
Selling and administration expenses 700
Full cost 3,800
At a glance, the order appears to be unprofitable. But suppose the firm has some idle capacity that can be utilised to produce output for new order. There may be more efficient use of existing labour and no additional selling and administration expenses to be incurred. Then the incremental cost to accept the order will be:
Rs.
Labour 600
Materials 1,000
Overheads 800
Total incremental cost 2,400
Incremental reasoning shows that the firm would earn a net profit of Rs 600 (Rs 3,000 – 2,400), though initially it appeared to result in a loss of Rs 800. The order should be accepted.
A simple situation in everyday life provides an example of incremental analysis. Consider a worker leaving work to travel home. Groceries are required and can be purchased at slightly higher prices at a store on the way from the work place to the home, or at lower prices by driving to a store 3 miles (4.82 km) from home. The worker decides to purchase the groceries on the way home since no incremental travel costs are involved, and the incremental difference in grocery prices will be less than the value the worker places on the time and other costs required to drive to the more distant store.