Incremental Revenue refers to the value of additional revenue of the company during the period under consideration if there is a change in sales quantity in the company and the incremental revenue is calculated by dividing the change in the revenue of a specific period by the change in quantity sold.
Incremental Revenue Definition
Incremental Revenue refers to the additional revenue generated from an additional quantity of sales. The incremental revenue is used to analyze and compare the revenue generated by two different strategies. A baseline revenue level is established, and it is measured on the basis of this baseline revenue. A baseline revenue level is a benchmark which would ascertain the budgetary effects of changes in liabilities and revenue.
Incremental Revenue Formula
The formula is represented as below,
Examples of Incremental Revenue
Pebble Technology Corporation is in the final stage of the development of its cutting edge technology smartwatch. The watch is one of its kinds and is bound to be a hit in the market owing to its specifications that make it special among its rivals. Although Pebble is sure of making it big, once launched, they need to calculate the incremental revenue.
Pebble would first need to arrive at a baseline revenue level. This example does not take into consideration the factors of depreciation and taxes. Pebble estimates a sale of 40,000 units. The selling price per watch is $200, and the cost of manufacturing a watch is $90.
The calculation of incremental revenue would be as follows,
= 40,000 x $200
Incremental Revenue = $8,000,000
The calculation of Incremental Cost will be –
Incremental Cost = No. of Units x Cost per unit
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= 40,000 x $90
Incremental Cost = $ 3,600,000
In this case, the sales forecast of 40,000 units would be profitable for Pebble which would bring in $ 4,400,000 of revenue.
With the help of this analysis, Pebble can then decide on how much of sales would result into a profit and how much needs to be mandatorily spent on marketing activities to reach out to maximum people who would, in the end, turn out to be customers due to the marketing activities.
Retargeting campaigns are perfect examples of incremental revenue. Online shopping has gained pace, and all of us have at least once added something to the cart and thought of buying it at some point in time in the future. Somehow we forget about the cart and the product we were to buy.
Online shopping websites capitalize on this! They send out emails and notifications of the items that you left out in the cart. They have created this mechanism to keep you reminded about the product that you once wished to buy, but due to your reasons ended up not buying it.
Most of us end up buying the product falling prey to the retargeting efforts put in by these websites. The cart you once abandoned has itself made you a customer without your knowledge. Moreover, they also send timely vouchers for the specific products in the cart (Special Accessory / Electronics / Clothing / End of Season Discount Coupons). It would ensure that you buy the product like the product that was once pricey seems to be cheaper after the discount coupon.
These discount coupons and retargeting efforts are the results of incremental revenue. Once the amount of money that is required to be spent on such marketing campaigns is identified, the businesses can go full-fledged to earn that additional profit.
Advantages of Incremental Revenue
- They provide proof of return on the investment made on the marketing campaigns.
- It has great potential in identifying how much should be spent on marketing and other publicity activities to generate additional revenue due to these activities.
- Incremental revenue is a deciding factor in terms of sales volumes and marketing campaigns that are required to be made for the business to earn profits.
- Incremental Revenue helps the management to analyze and arrive at a decision whether or not to adopt an alternative business plan to increase sales.
- They give a clear picture as to how an increase in the sales would bring in revenue or would result in higher costs.
- Unlike marginal revenue, which focuses on the revenue generated per unit increase in sales, incremental revenue focuses on the revenue generated from additional sales (does not depend on per unit. For example, an additional sale of 500 units).
- Businesses not only rely on marginal revenue for decision making but also give equal importance to the inference arrived at by incremental revenue.
- While launching a new product in the market, businesses have to forecast the sales that are required to be made for the product to be successful for which marketing strategies need to be formulated. Incremental Revenue provides a clear picture of how much to spend on marketing campaigns and how much to sell.
- If it is higher than the incremental cost of manufacturing or buying a product, the business would make a profit and vice-versa.
- Incremental revenue is the revenue earned due to a marketing campaign that was conducted to promote the product.
This article has been a guide to what is Incremental Revenue and its definition. Here we discuss formula, examples of Incremental Revenue along with advantages. You may learn more about accounting from the following articles –