What is a 'Shutdown Point'
A shutdown point is a point of operations where a company experiences no benefit for continuing operations or from shutting down temporarily; it is the combination of output and price where the company earns just enough revenue to cover its total variable costs. If a company can produce revenue greater or equal to its total variable costs, it can use the additional revenue to pay down its fixed costs, assuming fixed costs, such as lease contracts or other lengthy obligations, will still be incurred when it shuts down. In other words, when a company can earn a positive contribution margin, it should remain in operations despite an overall loss.
BREAKING DOWN 'Shutdown Point'The shutdown point denotes the exact moment when a company’s revenue is equal to its variable costs. At this moment, there is no specific benefit to continuing production or to ending it. If an additional loss occurs, either through a rise in variable costs or a fall in revenue, the cost of operating outweighs the revenue. At that point, shutting down operations is more economical than continuing, even if the company continues to experience losses in other areas, such as fixed costs. If the reverse occurs, continuing production is more likely.
The shutdown point does not include an analysis of fixed costs in its determination. It is based entirely on determining at what point the costs associated with operation exceed the revenue being generated by those operations.
Levels of Shutdown
A shutdown point can apply to all of the operations a business participates in, or just a portion of its operations. Certain seasonal businesses, such as Christmas tree farmers, may shut down almost entirely during the off season. While fixed costs remain during the shutdown, variable costs can be eliminated.
Other businesses may experience fluctuations or produce some goods year round while others are only produced seasonally. For example, Cadbury chocolate bars are produced year round, while Cadbury Cream Eggs are considered a seasonal product. The main operations, focused on the chocolate bars, may remain operational year round while the cream egg operations may go through periods of shutdown during the off season.
Fixed Costs vs. Variable Costs
Fixed costs are the costs that remain regardless of what operations are taking place. This can include payments to maintain the rights to the facility, such as rent or mortgage payments, along with any minimum utilities that must be maintained. Minimum staffing costs are considered fixed if a certain number of employees must be maintained even when operations cease.
Variable costs are more closely tied to actual operations. This can include, but is not limited to, employee wages for those whose positions are tied directly to production, certain utility costs or the cost of the materials required for production.