
Originally Posted by
Jobby
My question is all about the high low method, stating it's formula and details of what it's used for.
No need to memorize a formula--the underlying intuition of hi-lo is very simple, and once you grasp it you can apply it anytime.
Situation: I want to know how my
total costs are divided as between
fixed and
variable. The only information I have available at the moment is several observations of historical cost data, along with the number of sold units associated with each cost observation.
For example, I see that in one month I sold 150 units, and my total costs were $2,000. In another month I see that I sold 180 units, with total costs of $2,300 for the month; and so on. As you'll see, I need at least two observations to apply hi-lo, but if I have more than two I'll use the highest and the lowest in the calculation (hence the name).
To get my best estimation, I pick the highest and lowest of my data. Suppose that the lowest observation was a month in which I sold 110 units and incurred $1,600 of costs. The highest month was 195 units and $2,450 of costs.
So here's the simple deal: Between the highest and lowest, an increase in sales of 85 units (from 110 to 195) resulted in costs increasing by $850 (from $1,600 to $2,450). OK, 85 additional units produces $850 of additional costs--that tells me my variable unit cost must be $10 per unit.
From that, it easily follows that my
fixed costs are $500. At a sales level of 110 units, my
variable costs must have totalled $1,100 (at $10 per unit), and since my
total costs were $1,600, that implies that
fixed costs were $500 that month.
Similarly, at the high month, my
variable costs--at $10 per unit, and 195 units--were $1,950. With
total costs that month of $2,450, clearly my
fixed costs were $500.
That's it, amigo. Just remember that the actual relationship between fixed costs, variable costs, and sold / produced units rarely is perfectly linear. But in situations where the relationship is roughly linear, hi-lo will give you a good estimate of the fixed vs. variable breakdown of your costs.