What it means
As a non-finance manager, understanding how costs behave is vital for budgeting. Many expenses in a business are mixed, meaning they contain both a fixed part that stays the same regardless of output, and a variable part that changes depending on how much you produce or sell.
Think of electricity bills, which have a base meter charge plus extra costs for usage. The high-low method offers a fast shortcut to split these apart without needing complex statistical software.
To use this technique, you look at historical records over several months. You pick the month with the highest activity level and the month with the lowest activity level.
By comparing the difference in total costs between these two extreme points against the difference in activity, you can figure out the variable cost per unit. Once you have that rate, you can easily determine the fixed cost portion.
This helps you forecast future expenses more accurately. While this method is not as precise as advanced regression analysis, it is incredibly useful for a quick estimation.
Entrepreneurs and managers rely on it when they need a ballpark figure for pricing decisions or break-even analysis without spending hours crunching data. It gives you a reliable baseline to plan your operational spending and make informed business choices.
Remember that this approach relies entirely on two data points, which makes it vulnerable to unusual outliers. If your highest or lowest months were heavily disrupted by extreme weather or holiday closures, your calculations might be skewed.
Therefore, it works best when the chosen high and low periods represent normal business operations rather than strange anomalies.
In practice
Real-world examples.
Example
A local bakery looks at its utility bills over the year. Their highest month had 5,000 loaves baked for 1,200 pounds in power, and their lowest had 2,000 loaves baked for 750 pounds.
Example
A small delivery courier tracks van maintenance. Their busiest month logged 10,000 miles costing 4,500 pounds, while their quietest month saw 3,000 miles costing 2,400 pounds.
Example
A boutique hotel tracks laundry expenses based on occupied rooms. Their peak summer month had 1,500 guests costing 6,000 pounds, and a quiet winter month had 400 guests costing 2,800 pounds.
Think of it
“Imagine estimating your monthly mobile phone bill by looking only at your busiest month and your quietest month. By comparing the two, you can guess the base plan cost versus your extra data charges.
Formula
Calculation
Variable Cost per Unit = (Highest Cost - Lowest Cost) / (Highest Activity - Lowest Activity). Example: High cost 1,200 pounds minus low cost 750 pounds equals 450 pounds. High activity 5,000 units minus low activity 2,000 units equals 3,000 units. 450 divided by 3,000 equals 0.15 pounds per unit. Fixed Cost = Total Cost - (Variable Rate x Activity). For the high month: 1,200 pounds minus (0.15 pounds x 5,000 units) equals 450 pounds fixed cost.Case study
Seen in the real world.
GreenLeaf Landscaping wanted to understand its vehicle fuel costs to price upcoming commercial contracts. The firm reviewed the past year of data. The highest activity month was July, with 8,000 miles driven costing 3,200 pounds in fuel. The lowest activity month was January, with 2,000 miles driven costing 1,400 pounds. Using the high-low method, the finance lead subtracted January cost from July cost to find a 1,800 pound difference. Next, January miles were subtracted from July miles to find a 6,000 mile difference. Dividing 1,800 pounds by 6,000 miles revealed a variable fuel cost of 30 pence per mile. To find the fixed monthly lease and insurance cost, the team took the July total of 3,200 pounds and subtracted 2,400 pounds (30 pence multiplied by 8,000 miles), leaving a fixed cost of 800 pounds per month. Armed with this formula, GreenLeaf could now accurately predict fuel expenses for any prospective job.
Watch out
Common mistakes.
- Using months that are atypical or affected by unusual events as your high or low points.
- Assuming the cost behaviour is strictly linear when it might actually step up at certain capacity limits.
- Forgetting to match the correct cost figures with the exact corresponding activity levels.
Questions
People also ask.
Why is it called the high-low method?
Because it only uses the highest and lowest levels of activity from a dataset to perform the calculation.
Is this method completely accurate?
No, it is an estimation tool. Because it ignores all data points except the highest and lowest, it can be thrown off by unusual outliers.
When should I use a more advanced method instead?
Use more advanced tools like regression analysis when you have complex data with many outliers and need high precision for audits or major investments.
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