Many businesses, especially in retail, absolutely enjoy their Q4 sales. However, planning it can also be a tremendous stress.
So, it is no surprise that most retailers prepare for Q4 sales in the summer. But how do you plan a production based on the estimated volume?
This is where the high-low method becomes useful. It helps you quickly estimate your expected cost by averaging peaks and lows.
With our calculator, you don’t need any formulas; you can just input your volumes and costs and get results.
High Low Method Definition
The high-low method is a simple approach to estimating the variable cost per unit and fixed cost using historical cost data.
By taking the highest and lowest activity levels, you can determine the total cost and categorize it into fixed and variable costs.
High-Low Method Formula
To apply the high-low method, you start by identifying the highest and lowest activity levels and their corresponding total costs.
The formula to calculate the variable cost per unit and the total fixed cost is as follows:
Variable Cost per Unit = (Cost at High Activity Level − Cost at Low Activity Level) / (High Activity Level - Low Activity Level)Total Fixed Cost = Total Cost at High (or Low) Activity Level - (Variable Cost per Unit * High (or Low) Activity Level)These calculations form the foundation of cost analysis using the high-low method.
Example Calculation
Let’s say your business records 10,000 units of activity at a total cost of $50,000 (high activity level) and 5,000 units at $35,000 (low activity level).
- High Activity Level: 10,000 units
- High Activity Level Cost: $50,000
- Low Activity Level: 5,000 units
- Low Activity Level Cost: $35,000
Using the formula, calculate the variable cost per unit:
Variable Cost per Unit = ($50,000 - $35,000) / (10,000 - 5,000) = $15,000 / 5,000 = $3Next, determine the total fixed cost:
Total Fixed Costs = $50,000 − ($3 * $10,000) = $50,000 − $30,000= $20,000Now, it tells us that every additional unit produced costs $3 (variable cost). Regardless of the number of units produced, there will always be $20,000 in fixed costs.
By plugging in these numbers, you can see the calculation process.
Now that you have the data model, you can estimate the budget for the next period based on the number of planned units.
For example, you plan to produce 15,000 units in Q4. Now that you have variable and fixed costs, you can use the following formula:
Total cost = $20,000 + $3 * 15,000 = $65,000The most significant advantage is that this method simplifies forecasting and decision-making for future activities and pricing strategies by averaging the highest and lowest periods.
If you need quick results, an online tool or high-low method calculator can assist in these calculations.
Why Use the High-Low Method?
- Simplicity: It’s easy to use and understand.
- Quick Estimates: Provides quick estimates for planning and decision-making.
Limitations
- Accuracy: It may not be as accurate as other methods because it only uses two data points
- Outliers: The estimates might be skewed if the highest or lowest activity levels are outliers.