Managerial Accounting

a. Expand on John’s thought. How are the large losses related to fixed costs?

Even though the exact numbers are unknown, the numbers of employees (2000) and the scale of operations can easily contribute to having a high operating leverage (higher fixed costs in comparison to variable costs) type of business. If this is true John’s conclusion is correct. Businesses with higher operating leverage bear more risk in situations of slowing demand caused by factors like; loss of customers, growing competition, or economical downturns. It stems from the fact that profit is determined by three major factors, which are the components of profit equation, contribution margin (consisting of sales price and variable cost), the number of unit sold (dictated by sales and demand) and fixed costs. The higher the contribution margin and/or the greater the level of sales while fixed costs stay the same the higher the profit, and conversely, the lower the contribution margin and/ or sales number with fixed cost being constant the lower the profit.

b. Identify a way that John can turn potential fixed costs into variable costs.

Although the total elimination of fixed cost is impossible there are different ways that the company can convert some of its fixed costs into variable costs.

Since Pacific Electric is a company that provides electrical services to building construction projects, it could consider limiting the number of electricians that they hire and sign contracts with independent electrical contractors instead.

Since they operate in different states they could decide to limit their physical presence to only one of the states and getting rid of other buildings while establishing virtual presence.

Often companies like Pacific Electric have long term contracts in place for vendors and suppliers of goods and services. To minimize related fixed expenses, the company can negotiate