Understanding Cost Estimation: The High-Low Method Explained

What Is This Accounting Technique?

The high-low method accounting is a straightforward approach used by financial professionals to decompose business expenses into fixed and variable components. Rather than performing complex statistical analysis, this method leverages only the highest and lowest production points to estimate how costs behave at different activity levels. Whether measuring units produced, transactions processed, or service volume, the technique creates a practical cost model that reveals expense patterns without requiring extensive data sets.

This cost accounting approach assumes a linear relationship between activity and expenses—making it especially reliable for stable operations. The real power lies in its simplicity: you need just two data points to project future costs across multiple scenarios.

The Three-Step Framework

Step 1: Isolate the Variable Cost Component

The foundation starts with calculating the variable cost per unit:

Variable Cost Per Unit = (Peak Period Cost – Low Period Cost) ÷ (Peak Period Units – Low Period Units)

Identify which month or quarter had maximum activity and which had minimum. Look at actual production units (not dollars) to determine these extremes. This step reveals how much cost moves with each additional unit of activity.

Step 2: Determine Fixed Cost Baseline

Once you have the variable rate, calculate fixed costs using either the high or low point:

Fixed Cost = Peak Cost – (Variable Cost × Peak Units)

or

Fixed Cost = Low Cost – (Variable Cost × Low Units)

Both approaches should yield nearly identical results. If they diverge significantly, it signals a calculation error.

Step 3: Project Total Expenses

With both components identified, forecast costs at any activity level:

Total Cost = Fixed Cost + (Variable Cost × Projected Units)

Real-World Application Example

Consider a manufacturing company analyzing monthly costs. October represented peak activity with 1,500 units produced at $58,000 total cost. May was the slowest month: 900 units manufactured for $39,000.

Calculating Variable Cost:

Variable Cost = ($58,000 – $39,000) ÷ (1,500 – 900)
Variable Cost = $19,000 ÷ 600
Variable Cost = $31.67 per unit

Determining Fixed Expenses:

Using the high point:
Fixed Cost = $58,000 – ($31.67 × 1,500)
Fixed Cost = $58,000 – $47,505
Fixed Cost = $10,495

Verification with the low point:
Fixed Cost = $39,000 – ($31.67 × 900)
Fixed Cost = $39,000 – $28,503
Fixed Cost = $10,497

The consistency confirms accuracy.

Forecasting Future Costs:

For a projected 2,000-unit month:

Total Cost = $10,495 + ($31.67 × 2,000)
Total Cost = $10,495 + $63,340
Total Cost = $73,835

When This Method Delivers Value

Financial teams benefit most when rapid cost estimation is needed without statistical tools. Seasonal businesses use it to identify baseline expenses that persist regardless of volume, then measure variable components that scale with demand.

For small businesses with limited accounting infrastructure, the high-low method accounting provides defensible cost projections for budgeting and pricing decisions. Personal finance applications also work—utility bills can be analyzed to separate fixed service charges from usage-based consumption patterns.

Practical Limitations to Consider

The method’s reliance on only two data points creates blind spots. Extreme highs or lows that aren’t representative of typical operations can skew results. Additionally, assuming linear cost-activity relationships fails in environments with step-function expenses (costs that jump at certain thresholds) or economies of scale.

For operations with volatile or irregular cost structures, regression analysis or activity-based costing provides greater precision, though at the cost of complexity.

Key Takeaway

The high-low method accounting enables quick, accessible cost behavior analysis without advanced statistical knowledge. While not suitable for every situation, it serves as a practical starting point for financial planning, expense forecasting, and efficiency assessment across businesses of various sizes.