Is Your Utility Bill Lying to You? Deciphering the "Hybrid Cost" Fog.
Is Your Utility Bill Lying to You? Deciphering the "Hybrid Cost" Fog.
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How to Deal with Costs that have both Fixed and Variable Elements.
How to Deal with Costs that have both Fixed and Variable Elements.
Break-Even analysis is a critically important analysis for any business. The break-even point is the level of revenue at which a business begins to make profits. It provides a sales target the business should aim for.
Break-Even analysis involves segregating costs into Fixed (e.g. Rent) and Variable (e.g. Raw Materials). The assumption is that costs are either Fixed or Variable. But the real world is rarely that clean.
Many costs are Hybrid/Mixed costs, with both fixed and variable elements. Think of your electricity bill: you pay a flat fee just to have the lights on (Fixed), plus a usage fee based on how many machines are running and how long (Variable).
Most of the “leaks” in a business happen in these Hybrid/Mixed Costs. If you treat the whole bill as “Fixed,” you overstate your overhead. If you treat it as “Variable,” you miss your true breakeven point.
The Problem with “High-Low”
The Problem with “High-Low”
Traditional accounting uses the “High-Low” method to split mixed costs into Fixed and Variable components. It computes the variable cost per unit by using the forumula shown below:
Variable Cost per Unit = (Cost at Highest Activity - Cost at Lowest Activity) / (Volume at Highest Activity - Volume at Lowest Activity)
What it does is to divide the increase in costs by the increase in volume, taking two points - the highest activity and lowest activity points.
It’s simple, but it’s dangerous. It only looks at two data points - the months of highest and lowest activity. If one of those months was an anomaly (a power surge or a holiday shutdown), your entire cost model is wrong.
The Strategic Solution: Linear Regression
The Strategic Solution: Linear Regression
To get the truth, we need to look at the “trend line” across all your data points. This used to require a statistics degree. Now, it requires few lines of AI code. We have built a Hybrid Cost Splitter tool, and are making it available free to readers.
Click the Link to Cost Splitter tool. This will open a page with the code in one section and data entry boxes in another section.
Enter the production volumes for the last six months in “volume“ box, inside quotes and separated by commas.
Then enter the costs (for a selected hybrid cost for the same period, in the same order) in the “total_cost“ box.
If you have no business and no volumes and costs to enter, just keep the existing values in the boxes.
Now click the Play icon at the top left of the code box.
You will find the hybrid cost analyzed into Fixed and Variable elements in the results box below the code box. The code uses AI to do the work.
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