High-Low Method: A Simple Cost Estimation Tool
Small business owners often need a quick way to estimate costs. The high-low method offers a simple way to break expenses into fixed and variable components and use them to create a basic costing formula. It's important to understand how to apply it and when a more advanced method is needed.
What Is the High-Low Method?
The high-low method estimates fixed and variable costs. It uses two data points: the periods with the highest and lowest levels of business activity.
It's a fast, entry-level cost estimation method that separates costs into two parts: what changes with activity (variable cost component) and what stays the same (fixed cost component). You can use it to predict how total costs shift as you take on more work, deliver more products, or run more hours.
While not the most precise method, it's fast and easy to apply without advanced software or full cost reports. Greater precision requires more detailed calculation methods, ideally applied by an experienced small business accounting professional. The high-low method is only recommended for small businesses to understand cost behavior and make preliminary decisions.
How to Calculate the High-Low Method Formula
Here's how the method works.
Step 1: Find Your Two Data Points
Identify the periods with the highest and lowest levels of business activity. Record the activity units and total costs for each period.
Step 2: Determine the Variable Cost per Unit
Use the formula:
Variable Cost per Unit = (High Activity Cost – Low Activity Cost) ÷ (High Units – Low Units)
Step 3: Calculate the Fixed Cost Component
Pick one of your data points and plug it into this formula:
Total Fixed Cost = Total Activity Cost – (Variable Cost × Units Produced)
Step 4: Build Your Total Cost Formula
Plug in your results from Steps 2 and 3 and it's ready to use:
Total Cost = Fixed Cost + (Variable Cost × Units)
Examples of the High-Low Method
Here’s how the high-low method looks in action for two types of businesses.
Example 1: Estimating Manufacturing Costs
Let’s say a small toy manufacturer in Jacksonville, FL, decides to use the high-low method to predict their costs at any production level.
Find their two data points:
Highest Activity: 1,000 units with a cost of $12,000
Lowest Activity: 400 units with a cost of $6,000
Calculate their variable cost per unit:
(12,000 – 6,000) ÷ (1,000 – 400) = $10 per unitUse their high data point and calculate their fixed costs:
12,000 – (1,000 × 10) = $2,000 fixed costBuild their cost model formula:
Total Cost = $2,000 + ($10 × units produced)
Example 2: Forecasting Labor Costs for a Service Business
A small advertising agency needs to forecast its labor expenses as client demand shifts.
Data Points
Highest Activity: 180 billable hours, $9,600 in labor costs
Lowest Activity: 80 billable hours, $5,600 in labor costs
Variable Cost per Hour
(9,600 – 5,600) ÷ (180 – 80) = $40 per hourFixed Cost
Using the lowest activity data:
5,600 – (80 × 40) = $2,400 fixed costCost Model Formula
Total Labor Cost = $2,400 + ($40 × hours worked)
When to Use the High-Low Method
The high-low method works best when you need a fast estimate and don't have access to detailed cost records. It’s useful for early-stage planning, rough budgets, or spotting trends. With just two data points, you can model how your costs respond to changes in your business's activity.
Risks of Relying Only on the High-Low Method
The high-low method leaves out everything between your highest and lowest activity data points. If either point is an outlier, the results can be misleading.
It also assumes your costs behave in a straight line, which isn't always true. In reality, you might change your rates as a client's volume increases, or your costs may vary due to seasonal price fluctuations.
Small businesses should treat this method as a rough estimate, not a final answer. Relying on incorrect costing information could lead to cash flow problems, which is one of the top reasons nearly half of all small business startups in the U.S. fail in the first five years.
For reliable forecasting, budgeting, or tax planning, work with an accounting professional who can review your full cost structure in detail.
Alternatives to the High-Low Method
The high-low method is fast, but not always accurate enough for detailed cost planning, so what are your alternatives?
Scatter Graph Method
This method plots cost data on a graph to visually identify patterns and outliers. It is useful for identifying mixed costs and seeing whether a linear trend might exist. However, the scatter graph shows a rough estimate, not the exact cost—so the results may be off.
Regression Analysis
Regression analysis uses all available data points to estimate variable and fixed costs by measuring the relationship between cost and activity. It is more accurate than high-low or scatter graph methods, especially when your expenses don't follow a perfect linear trend.
If your business has irregular expenses or complex pricing structures, regression analysis offers a clearer picture. Consulting with an accounting professional will help you determine the best tool for your situation.
Schedule an appointment with our accounting professionals to find the best costing method for your business.
When to Consult With a Professional
Use the high-low method as a helpful starting point. However, work with a professional when you need deeper analysis in order to make confident financial decisions based on facts.
An accounting professional will classify costs more accurately, especially when your expenses don't follow a simple pattern. They can also spot seasonal trends or unusual spikes that distort your estimates.
If your business is growing or planning for the long term, a professional can recommend more advanced costing methods that give you greater accuracy and control.
Good for a Snapshot, Not a Strategy
The high-low method gives small businesses a fast way to estimate costs using minimal data. It helps break down fixed and variable costs and gives you a simple formula to model cost behavior. This can be valuable for early planning or setting budget expectations when detailed records aren't available.
However, this method has clear limits, especially when accuracy matters most. It overlooks data points between extremes and may distort your numbers if either value is an outlier. For more accurate insights, it’s smart to work with a tax and accounting professional who will analyze your full cost structure and provide sound guidance for long-term decisions.
