Sunday, February 22, 2009

Fixed Expenses – Recipe for Bankruptcy

Although people know the auto industry is in serious trouble, they do not understand the main reason so many of them are in danger of bankruptcy. Simply put, automobile companies face enormous fixed costs. Why?

  1. Debt – all the automakers have a relatively high amount of debt on their books. No matter how many cars they sell, or don't sell, they must pay a pretty big nut.
  2. Plants and Equipment – if a plant makes 100 cars or 10,000 cars, the cost of "owning" the plant and equipment does not change.
  3. Union Costs – the biggest mistake the automakers made over the years was allowing the UAW to force them into contracts that force them to pay workers to stay home and to pay high retiree costs – even if cars are not being made.

Bottom Line – unless they can bring down their fixed cost to reflect the lower demand for cars, they are doomed to bankruptcy.

This lesson applies to personal finance. They higher your fixed costs (in real dollars), the greater the chance you will face bankruptcy. Our fixed costs are:

  1. Debt payments – mortgage, car payments, student loans, and credit card payments can add up to a big number. While I don't believe everything Dave Ramsey says, lower debt can free most of us from financial ruin.
  2. Honestly, nothing else matters. Almost nobody goes bankrupt from rent payments, food bills, or clothing. Other than debt, the other big driver of bankruptcy is unexpected expenses that drive up debt – car and house repairs and medical expenses being the major causes.

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