Barriers to Exit

I’m confused about the notion of barriers to exit. If cash is king, then if you’re operating at a loss, you don’t have much time until you no longer have enough funds to keep your creditors happy. So to me, it seems like you’re going to run out of money well before a time when you decide to close up shop despite high exit costs. I don’t understand how you can keep your doors open for extended periods of time if you’re operating at a loss?

If you have a 2-year lease on a warehouse that costs you $20,000 per month, and you can cover all of your variable costs plus $5,000 per month by continuing operations, then you’re better off continuing: losing $15,000 per month for 2 years is better than losing $20,000 per month for 2 years.

Ignore the sunk cost. Make a decision on marginal cash flows.

You make 2000 of sales, fixed costs 500 (it’s fixed; you must pay whether you operate or not) and variable cost of $ 1800.

Would you keep operating, making the 2000 and losing 300 (2000 - 1800 - 500) ? Or you shutdown, making zero money, zero variable cost, but yet must pay $ 500 of fixed cost (loss=500)??

That’s the point. You better continue operations and lose $300 each month/year, rather close down that division and lose $500 each month/year.

Think this situation the other way. What is not affected from ceasing or not ceasing operations, is that fixed cost ($500). You will pay whether you operate or not. Your sales ($2,000) are higher than variable costs ($1,800) (making positive contribution margin in amount of $200). If you continue operations, you will make positive contribution margin ($200), if not, then 0. Obviously, you will choose to continue operations and you will be able to cover partly that fixed cost with this positive margin.