118 Understanding the Numbers
is called visual fitbecause one simply draws a straight line through the data
that “best fits” the pattern (see Exhibit 3.13). The point where this line inter-
sects the y-axis yields an estimate of the fixed cost component—those costs
that exist even without any sales activity. The slope of the line drawn is de-
fined mathematically as: rise over run or change in y-axis values divided by the
change in x-axis values. Using business rather than mathematical terminology,
how much the total costs change (the y-axis or rise) as the sales volume changes
(the x-axis or run). As was discussed above, this is simply the variable cost ex-
pressed as a percentage of sales. For the Books “R” Us example, given the line
I’ve drawn subjectively, the result would be:
With today’s computer software, this method is easy and time efficient. Unfor-
tunately, it lacks verifiability. If 20 people were to analyze this same data set,
you could end up with twenty different cost structure estimates.
The second method is called high-low analysis.It also is time ef f icient
and has the added advantage of verifiability. Since it is rule based, all twenty
people in this case would arrive at the same estimate. It has four steps:
- On the x-axis, identify the high and the low points of the data set.
- Identify the historical costs for each of those points.
- Assume a straight line through these two points and calculate the variable
cost component using the traditional slope equation: - For either the high or the low set of data points, plug the values into the
cost equation and solve for the fixed cost component.
SlopeChange in - xis Values
Change in - xis Values=yA
xAFixed Cost Estimate: line crosses -axis at about million dollars
Variable Cost Percentage of Sales Estimate Slope: about 85.2%^9y $4
=EXHIBIT 3.13 Books “R” Us scatter plot.
0 5,000 10,000 15,000 20,000 25,000
Revenue ($)Total Cost ($)05,00010,00015,00020,00025,00030,000