When a Business Temporarily Closes After a Shutdown point: Pros and Cons

The first and primary benefit of a business stopping operations after crossing a shutdown point is that it won’t run the risk of losing money during ongoing production. It also gives management time to re-evaluate future business prospects and current company procedures.

There are negatives, however, including the prospect of negative press coverage or loss of investor confidence. Businesses also have to consider client relationships, employee pay, and any perishable resources.

Key Takeaways

• There are several significant differences between shutting down and going out of business.
• One advantage of a shutdown is that it’s temporary.
• A temporary closure can result in negative press and this can hurt the business.
• A lot of professional relationships can be affected by a decision to temporarily stop operations.

Understanding the Shutdown Point

A shutdown point in managerial economics is reached when a business no longer has sufficient revenue to cover its variable costs. The idea is that the firm will save money or at least lose less by shutting down production. This isn’t the same as going out of business. It’s a temporary cessation of activity while assessing other options.

The shutdown point is the minimum price at which a producer would financially prefer to stop operations rather than continue. It’s similar to a store deciding to close at 6 p.m. instead of 9 p.m. because it expects revenue will fall below the cost of keeping the store open an additional three hours.

Marginal Revenue and Average Variable Costs

A business should cease production as soon as marginal revenue equals variable costs if it only cares about making economically efficient decisions. Any units produced beyond this point result in a net loss. They no longer help to recoup fixed costs or produce a profit.

Marginal revenue is the amount of net income a business receives from producing one additional good. Variable costs depend on production volume such as the costs of raw materials or wages paid to certain workers.

Important

A variable cost is distinguished from a fixed cost such as rent or insurance.

Suppose a firm incurs $12 worth of expenses when creating its product. It wouldn’t make sense to churn out any units with a market value of $11 because the firm would lose $1 per unit. The firm can instead decide to close temporarily after its shutdown point and attempt to find a way to reduce its variable costs.

Negative Press

Not all businesses receive a lot of press attention but consider the potential fallout if a large corporate brand like Nike or Purina decided to institute a temporary closure. Investors and customers would likely lose faith in the company and it could reasonably be expected that sales wouldn’t resume at pre-closure levels when the doors reopened.

What Is a Cost-Benefit Analysis?

A cost-benefit analysis weighs the expense of a project against what stands to be gained from entering into it. A potential project should be shelved if the cost exceeds its possible benefits.

What Is a Shutdown Zone?

A shutdown zone occurs between the time when it becomes apparent that a breakeven point can’t be achieved and when the business ultimately decides to permanently close its doors.

What Is a Sunk Cost?

A sunk cost is a type of fixed cost. It’s already been incurred and the business has no way of turning back and taking it back. Perhaps it purchased an expensive item of equipment that’s now defunct or inoperable and can’t be resold.

The Bottom Line

A lot of professional relationships in an integrated, specialized and global business environment could be affected by a decision to temporarily stop operations. Employees might have to be sent home for extended periods. Vendors, distributors, and other third parties would have to scramble to find new partners. The decision probably incorporates long-term effects that aren’t included in a limited cost-benefit analysis.

Some businesses may also have perishable inventory or other short-lived assets. The businesses would have to account for these assets before executing a temporary closure.