Question

Small business owner Jay Goltz described several decisions he made to reduce the fixed costs of his businesses, including replacing halogen lamps with LED lamps. Goltz noted, "I'm guessing that many business owners could save a lot more than pennies on their fixed costs, and those savings ... fall right to the bottom line."

a. Why are the costs of electricity used to power the lights used in Mr. Goltz's businesses fixed costs?
b. Explain why Goltz wrote that reducing fixed costs results in savings that "fall right to the bottom line."

Answer 1

A) Electricity costs are considered fixed costs because the company must pay them regardless of the volume of output. The cost of electricity varies from month to month since the consumption level is not always exactly the same, e.g. one day you turn on your computer 10 minutes earlier and your electric bill will increase a few cents. But generally speaking, the electric bill varies very little and it is fairly constant around certain average level.

B) A business's bottom line is net profits, and net profits are calculated by subtracting fixed costs and variable costs from total revenue (and taxes of course). If the fixed costs decrease, your net profit will increase.