What is a shutdown point?

A shutdown point is when a business determines it is not profitable to continue operating and, as a result, chooses to close down, either permanently or temporarily. It is the outcome of combining pricing and production when the business makes enough money to pay for all its variable expenses. The shutdown point, or when the marginal profit becomes negative, is the precise point at which a company’s variable (marginal) expenses equal its (marginal) income.

How the Shutdown Points Work

There is no longer any financial incentive to continue manufacturing beyond the cutoff point. In the event of a further loss resulting from either an increase in variable costs or a decrease in sales, the operating expenses will surpass the income.

It makes more sense to stop operations at that moment than to go on. It makes more sense to continue producing if the opposite happens. A business may use the extra money it makes to pay down its fixed costs if all its variable expenses are met or exceeded. This implies that fixed charges, like long-term debt or leasing agreements, will still need to be paid after the business closes. Even in the event of an overall marginal loss, a business should continue to operate if it can generate a positive contribution margin.

A shutdown point may pertain to all or just some of a company’s activities.

Particular Shutdown points to Remember

The shutdown point is determined without considering a study of fixed expenses. It all comes down to figuring out when the marginal expenses of activities outweigh the money those operations bring in.

Some seasonal enterprises, like producers of Christmas trees, could close almost entirely in the off-season. Variable expenses may be eliminated during the closure, but fixed costs persist.

Fixed costs are expenses that don’t change based on activities. In addition to the minimal utilities that must be kept up, this includes payments for the upkeep of the facility’s rights, such as rent or mortgage payments. Minimum staffing expenses at the shutdown point are deemed fixed if a certain workforce level has to be maintained, even if operations are terminated.

Variable costs have a closer relationship to the actual activities. This may include, but is not limited to, workers’ pay in jobs where production directly results from their work, the price of materials needed for manufacturing, or specific utility bills.

Shutdown Points Types

The duration of a shutdown point might be brief or permanent, depending on the specific economic circumstances that gave rise to it. A recession may result in lower consumer demand for non-seasonal items, necessitating a temporary (complete or partial) closure until the economy improves.

Other times, a shift in customer tastes or technological development causes demand to disappear entirely. For example, no one manufactures computer displays or cathode-ray tube (CRT) TVs anymore, and starting a factory to make them would be a losing venture.

Some firms have seasonal variations in their output, while others manufacture certain commodities year-round. For instance, Cadbury Cream Eggs are regarded as a seasonal product, while Cadbury chocolate bars are made all year round. While the cream egg activities may have periods of downtime during the off-season, the primary operations, which are focused on the chocolate bars, could continue to run all year round.

Conclusion

• A shutdown point is when a business determines it is not profitable to continue operating and, as a result, chooses to close down, either permanently or temporarily.
• A shutdown point is reached when production and price are balanced so the business makes enough money to pay for all its variable expenses.
• Shutdown points depend on determining when operating expenses exceed the income such activities produce.
• Even in the event of an overall marginal loss, a business should continue to operate if it can generate a positive contribution margin.