by A shut-down decision is that the firm is temporarily suspending production. It does not mean that the firm is going out of business. The shut Down decision depends on Shut Down Point. The shutdown point denotes the exact moment when a company’s revenue is equal to its variable costs.
A Shutdown point is a position of operation at which a company is receiving no advantage for continuing operations Thus, decides to shut down temporarily or in some cases permanently.
Loss-making segments of a business such as products, customers, and locations can be a significant drain on the resources of an organization.
Keeping a segment of business that is consistently generating a loss can be hard to justify, especially if its economics are unlikely to improve in the future.
Shutdown decisions can, however, be daunting for a business because of the time and resources invested in the failing enterprise. Shutdown problems should also consider the long-term implications of the decision.
The shutdown point denotes the exact moment when a company’s revenue is equal to its variable costs. Variable costs such as wages, production supplies, etc. It results from the combination of output and price where the company earns just enough revenue to cover its total variable costs.
Reasons of shut down production
- Financial problem
- Fall in demand
- Change in technology
- Inadequate availability of raw material
- High rate of taxes
- Recession in market
- Mismanagement
Shutdown Point
Theoretically, a business should discontinue any activity that does not generate sufficient funds to pay for its expenses in the long term (i.e., positive net cash flow).
When assessing shutdown problems, it is essential to consider only the relevant costs of business activity.
Examples of relevant costs include:
- Direct fixed costs which are avoidable in case of a closure.
- Variable expenses such as direct material and direct labor.
- Opportunity cost of continuing a business activity.
Examples of non-relevant costs include:
- Sunk cost (e.g., cost of machinery).
- Non-cash expenses (e.g., depreciation)
- Committed expenses which are unavoidable;
- ‘One-off’ revenues and expenses (e.g., sale of machinery, redundancy payments, etc.) that do not reflect the underlying profitability of the business.
Types of Shutdown Points
The length of a shutdown can be temporary or permanent, this depends on the nature of the economic conditions which is leading to the shutdown. For the non-seasonal goods, in an economic recession, this may reduce the demand from the consumers, after forcing a temporary shutdown (partially or totally) until the economy recovers from this.
Yet at other times, the demand dries up completely for the changing consumer preferences, also for the technological upgrade. For example, nobody produces the cathode-ray tube (CRT) televisions or computer monitors any longer, and thus this would be a losing prospect to open a factory such as these days to produce the same.
Other businesses also may experience the fluctuations or produce some goods year-round, while others are merely produced seasonally. For example, the Cadbury chocolate bars are produced year-round, while the Cadbury Cream Eggs are considered as a seasonal product. The main operations will be focused on the chocolate bars, which may remain operational year-round, while the cream egg operations will have to go through periods of a shutdown during the off-season as well.
