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The shutdown point indicates that a company's earnings cannot be increased in the future. It is the point at which a company should decide to stop producing in order to avoid incurring a larger loss.

Even though the firm is losing money, it should not close if the average variable cost of production can be recovered from earnings. The two categories of costs that organizations confront are fixed and variable costs. Variable costs change with the quantity of output, but fixed costs do not. If the pricing level is lower than the average cost, the firm will lose money. It is not, however, the time to consider shutting down operations. As long as the firm can repay the cost of the inputs it requires, it may continue to operate and wait for a positive turn of events. If the situation is such that the business cannot even recuperate the variable cost of production at the present price level, the activity must be shut down.