You may have heard someone say that expense savings go right to the “bottom line”. What does that mean? What is the bottom line anyway?
For a business, the last line on the income statement is net income. Income statements are one of the core financial reports for a business (along with balance sheets and cash flow statements). Some old-school companies like mine still call them P&L (profit and loss) statements.
Let’s say this is the income statement for last month at Gracie’s Hot Dog Stand. Gracie sells the hot dogs for $1 a pop, and she buys the buns and dogs from the wholesaler at $0.50 a pop (Cost Of Goods Sold). She pays a whole bunch of other expenses before brining $100 to the bottom line, or putting $100 in the bank at the end of the month:
Next month Gracie works real hard and brings in an extra $500 in sales. But what happens to this $500? First it gets cut in half by the cost of the extra dogs and buns. Then the variable costs, like extra salary and marketing to get those increased sales, march right up proportionately with the sales increases. She only makes an extra $75 in profit from $500 in increased sales.
The next month Gracie tries a different approach. She fires her maintenance worker, and finds someone to oil the wheels on the hot dog stand for a flat $25 per month. She also stops buying her office supplies from the fancy stationery store, and just goes to Walmart, which reduces her supplies and general expenses to $25 too. The $50 maintenance savings and $50 supply savings increase her profit by $100, or in other words, the expense savings went right to the bottom line! Gracie had to increase sales by $500 before just to get $75 in profit.
And here’s the best part. Now if Gracie’s sales go up in the future, she’ll bring more to the bottom line as a percentage of sales thanks to her lower cost structure. That’s called leveraging sales.
Does this work for personal finance too? Let’s see.
Jack works was a software engineer making a salary of $52k/year, and, after years of hard work, he just earned himself a 10% raise. Here’s what his paycheck looks like before and after the extra $100/wk raise:
Jack made an extra $100/wk in gross earnings, of which only an extra $64/wk showed up in his checking account. In other words, he had to get his boss to pay him an extra $5,200/year just get an extra $3,300 in take-home pay. And those ratios get worse in higher tax brackets.
If Jack could learn lesson or two from his sister, and say cut cable, what would happen? Well, Jack is a big pop culture junkie. He has the super-premium cable package for all 8 of his TVs and he rents a bunch of movies on demand each month. He pays $275 per month in cable! If Jack cut the cord, he’s save about $3,300 per year in real take home pay. He’d have to get another 10% raise, or work 10% more just to pay for that cable bill.
- Maybe he buys a cheap used car instead of renewing his BMW lease.
- And maybe he uses his tax return to pay off that credit card he’s been making minimum payments on instead of buying a Movado.
- And maybe he starts shopping at Aldi instead of shopping at Whole Foods.
- Maybe all that adds up to $1,000 per month in expense savings.
Those small changes would be the same as Jack convincing his boss to pay him almost an extra $20k per year or give him nearly a 40% raise!
Bottom line: expense savings at your company and in your personal finances bring more money to the bottom line than the same dollar increases in income. And expense savings make future income increases even sweeter!