A business has many values, which is why it can be tricky when investing. While certain values represent one aspect of a company, it can differ from another value that outlines a different aspect of the same business. For example, liquidation value is a term we hear often in the investment world. But what does it mean and what is its impact on business?
Liquidation value is the value that’s realized once a company sells their physical assets and settles their debts in the event of a closure or if the company steps out of business. It only focuses on the physical aspects of the company, such as real estate, equipment and inventory.
Intangible assets, such as intellectual property or brand recognition, are not included in the liquidation value. However, if a business is being sold rather than liquidized, both the physical and intangible assets would be included in the company’s going-concern value.
The purpose of liquidation value is to provide the buyers or owners of a company a better picture of the business’ overall capital value. It also plays a factor in a business owner’s decision to close or sell their business.
In many cases, they may want to determine if it would be beneficial to liquidate the business – which it could be if their calculations prove their estimated gains would be less than the liquidation value. This is a common tactic companies use if they are considering declaring bankruptcy or selling their business.
However, other investors look to the liquidation value of a company to determine its risk. Lenders and bondholders often take the liquidation value into consideration for applicants. Potential buyers interested in purchasing the company may evaluate the liquidation value the business to determine if it’s a good investment.
Calculating Liquidation Value
To calculate liquidation values, most companies follow this method:
– Review the most recent annual report. It can be obtained from a company’s Investor Relations department or downloaded directly from the company website.
– Review the tangible assets and liabilities. Tangible assets are the complete range of property and assets owned by the company that could be sold in the market. Liabilities represent the company’s debt outstanding.
– Subtract the liabilities from the assets. This determines the expected liquidation value.
In most cases the tangible assets will not be able to raise the value that they are listed for on the books in the event of a fire-sale, or liquidation. Appropriate adjustments will need to be made to reflect this scenario.
Whatever reason you are investing, remember it’s important to look at the entire picture of a company’s worth. Knowing the liquidation value gives you a good idea of what to expect in the worst case scenario of the company declaring bankruptcy. For your own company, it’s recommended to keep track of your business’ liquidation value, especially before making large decisions like closing, merging or selling your business.