[3] Using a factory as an example, fixed costs can include the leasing of the factory building and insurance, while the variable costs include overtime pay and the purchase price of the raw materials.
A factory costs £5000 per week to produce goods at a minimum level and due to high demand it has to produce for an extra 20 hours in the week.
Including the wages, utility bills, raw materials etc.
, we calculate: The total cost would be £11,000 to run the factory for this particular week.
If the variable part of the cost is not linear, calculating an estimate can be more difficult.
By identifying the time period where production is at its highest and its lowest, and inputting the figures into the high–low equation, we can separate out the variable and fixed costs.
is the total variable cost at the high end of activity,
This estimate can now be used with the linear formula from before; if the factory is going to run for 60 hours in the coming week, the total cost
A major advantage of the high-low method is that it is relatively simple to calculate.
This enables an estimate for the fixed costs and variable costs can be found in a short time, with only basic mathematics[3] and no expensive programs to run the calculations, allowing for the firm to invest their finite resources elsewhere.
This is particularly useful for smaller firms which do not that the budget to afford external, more qualified accountants.
[9] As this particular method only uses the highest and lowest figures it means individuals in companies can simply research the data in the company database (as the total costs and scale of production would be widely available to employees or easily attainable).
This would allow all employees in the business to calculate the semi-variable costs and its components easily resulting in them having a better understanding of how the company performs and its expenses.
[11] As it only uses two sets of data, the highest and lowest, it can be largely unreliable as often firms can have high variances in production levels and this method would not be able to capture the average activity levels.
[5] Another major drawback of the high-low method is that only one variable is taken into account.
For example, if the variable cost is measured by time (e.g. per hour), but the firm wants to produce at a higher level than it ever has before, expansions costs (such are buying more equipment, hiring more people, etc.)
This could lead to the firm's bottom line eroding as the individual would estimate lower costs than what it would occur and profits would be lower than expected.