What is incremental analysis? If you’ve studied either macroeconomics or managerial accounting after high school, you are probably very familiar with the term. According to Investopedia,
An incremental analysis is a decision-making technique used in business to determine the true cost difference between alternatives. Also called the relevant cost approach, marginal analysis or differential analysis, incremental analysis disregards any sunk cost.
Incremental analysis is crucial when it comes to business problems. Usually people may offer confusing solutions that don’t really help you weed through important metrics, data points and purposed solutions, as well as, our topic of conversation, incremental analysis.
The four facets of this type of analysis are:
· Opportunity Costs
· Sunk costs
· Relevant costs
· Unchanging costs
By working through each of these areas, you can effectively solve problems in the workplace and arrive to solutions quickly and effectively.
Sunk costs enable you to single out factors that are out of your control – costs that you’ve already spent and that are irrelevant now. An example of this is impacting your pipeline and then realising that there is a 6-month buffer that you need to build before you can do so.
With sunk costs out of the way, you can move on to sourcing out opportunity costs. These costs determine what you are sacrificing when you choose a course of action as this impacts other items once you begin. An example of an opportunity cost is adding an advertising banner onto your website. For you to be sure it is effective, you will need to consider opportunity costs first before assuming that it will add value to your website.
These costs do not get affected by your changing decisions. Unchanging costs are always irrelevant. An example of this is if you have a website page that is perhaps pulling through viewers but is not pulling through any conversions, deleting this page will not affect your return on investment in any way. Realising which costs are unchanging will enable you to determine relative alternative solutions for your business.
All costs that are not sunk costs or unchanging costs are relevant costs and should be monitored closely.
Incremental analysis is essential in the business word for solving questions and reaching successful solutions. For more information, read David Avery’s article: Pearls of Wisdom are Hidden in Your Data.