Liquidation Value
It is the company's final worth after selling its assets.
What is Liquidation Value?
Liquidation value, also known as liquidation valuation, is the company's final worth after selling its assets. The assets that are part of the liquidation valuation are tangible assets, such as property, plant, and equipment (PP&E).
It is important to note that intangible assets are not considered in the liquidation valuation. This situation usually occurs when a company goes out of business, goes bankrupt, or shuts down operations in a particular city or area.
In addition, all the tangible assets are usually sold within a year of closing. The business will usually sell tangible assets such as land, real estate, and heavy machinery at a lower price than their book value to sell them quickly.
Liquidation valuation is a financial instrument used to calculate and forecast the worst-case scenario of a business if it goes bankrupt. It is also applied when a successful business considers merging, going public, or requesting loans from its creditors or investors.
Intangible assets are non-physical assets that cannot be touched or felt. These include brand loyalty, licenses, and trademarks.
If a business is liquidated, the intangible assets will not create any value. Still, investors will determine what the intangible assets are worth if a business is sold.
It is comparable to the market price of a business's inventory. Therefore, when the market price tends to be less than the liquidation price, it is fair to assume that investors are likely to have less confidence in the company's management and future success.
The minimum worth of a business a buyer wishes to purchase can also be calculated using the liquidation value. Again, the price paid establishes the lower limit of likely bid amounts, even if it is unlikely that the price paid will be this value.
Liquidation Value Variations
When a firm is being liquidated, it is very important to sell its assets quickly and at the best price possible. However, the different variations are impacted by different times; therefore, one could be better in certain situations. Some of the variations are:
1. Orderly Basis Liquidation Value
Orderly based is when the liquidation process is carried out in a planned approach. This is also known as OLV. The firm, the seller in this situation, invests a certain amount of time in identifying and assessing potential purchasers and their potential offers.
OLV is when a firm gets an agent who will try and sell the tangible assets to the best purchaser available. This process is done within a reasonable amount of time, and the firm gives the agent a cut-off date for when the assets should be sold.
The agent must get the best offer possible for the firm.
2. Forced Basis Liquidation Value
Another variation is the forced process, also known as FLV. This process occurs if the firm sells all of its assets quickly, usually in an auction process.
The FLV process estimates the company's financial position under the worst-case scenario. The firm uses the FLV to know what the assets are worth if they sell them quickly. Usually, they are cheap.
Due to many issues with the FLV, the company's forced liquidation value will frequently be less than 25% of its true market value. This value is, therefore, mostly utilized for financial measurements and rough estimates.
3. Replacement Value
Lastly, another variation is called the replacement value, known as the cost approach. This variation is usually used for property.
When an informed buyer wants to make an offer on a company’s property that they are willing to sell, he will not offer a price higher than it could take him to build that building.
When a buyer is looking to purchase a property (buildings, offices, or a factory), they should consider how much they would need to spend renovating, reconstructing, and customizing the building to fit their business. They would need to spend that much in addition to the actual price of the property itself.
The approach considers the cost paid to construct a property today. The current building would need to be torn down and rebuilt from scratch.
Levels of Valuation for Business Assets
There are four levels for evaluating a business's assets. The different levels provide information that analysts will need to see the true value of the assets. The levels of valuation are;
- Market (auction) value
- Book value
- Liquidation Value, and
- Salvage value.
Market value is the amount a certain asset sells for on the market. A publicly listed company's market capitalization, determined by multiplying the total share amount by the current share price, is referred to as its "market value."
The price at which buyers and sellers exchange goods is known as the "market price." It is solely based on supply and demand. Thus, the buyer's ability to pay and the seller's acceptance of the offer must be equal.
It can also be said that it's an exchange with the consent of the buyer and seller at the ongoing market price for the commodity or service.
The difference between market price and market value is that market value (open market valuation, OMV) operates under fair market conditions.
A fair market is when the buyer and seller have a reasonable amount of information about each other and have time to decide. Finally, the decision must be agreed upon by both parties.
OMV is calculated using many different financial tools. Thus, there is not one way to see a company OMV at once. However, people can compare companies to rival companies by looking at their OMV or market capitalization.
Identifying the market value of private businesses whose financial information is not publicly available can be challenging.
A private company’s success is often evaluated by comparing its value to publicly traded companies in the same sector with comparable sizes and growth rates.
A company's book value is its assets, less its liabilities. The corporation's balance sheet contains the book value; it is significant to highlight those intangible assets that are not considered. When combined with market value, book value can be useful for learning about a company.
In addition, when comparing book value to market value, an analyst can see if a stock in the company is overpriced or underpriced. In addition, book value can show how much the shareholder would earn if the company were to be liquidated.
Hence, investors and traders should pay particular attention to other assets that may not be well presented in the book value because it does not show the full picture.
Salvage value is what an asset is worth after it has undergone depreciation; a business will anticipate receiving a specific sum of money, much less, after an asset's useful life.
Bigger companies tend to depreciate their assets until they are worth nothing; they do this because salvage value is so low that it does not bring them any competitive advantage. Depreciation includes salvage value as one of its elements.
A risk for investors is that the salvage value can be fraudulent. Companies could easily estimate a higher salvage value for particular assets and not show depreciation properly, leading investors to believe that the company is making higher profits, which is not the case.
Liquidation Value Analysis
Before making a financial commitment to a company, potential investors would carefully consider the company's liquidation value.
This is because people are curious about what will happen to their investments and how much would be compensated in the event of bankruptcy.
The decision to liquidate is based on the assumption that a trusted agent is assigned to oversee the liquidation and distribution of the remaining funds.
Firstly, assets that are not liquid, hard to sell, or convert into cash will be sold much cheaper than liquid assets.
Assets that are not liquid will be cheap because the buyer will not be able to use them without making certain modifications to them or if those assets are customized to that certain company (the debtor).
To calculate liquidation, you will need to subtract the assets from the liabilities but not include the intangible assets, as they are not worth anything. The business will need to accept the recovery rates.
For cash, cash equivalents account receivables, and inventories, the company is likely to get at least 50% of what the assets were worth when they sell them.
The assets used and/or customized for the company are usually sold for 20% of what they were worth when they were acquired.
When considering liquidation, it is important to note a few procedures.
- Both the seller and the buyer agree.
- The seller is under an obligation to sell their assets.
- The buyer should be motivated to buy those assets.
- The seller and buyer act in their best interests (business and personal).
- The sale will be completed in a short period.
How to Calculate Liquidation Value
For example, an individual runs his business; he sells food out of his truck. Over the past few years, the revenue has been steadily increasing, but everything suddenly changed.
The last few months have been very slow and have made it hard to cover the day-to-day costs, so the owner has decided if he should sell.
He uses this value method to sell his assets quickly. First, the owner will need to find the book value for all his tangible assets; these can be found on the balance sheet. After that, he will determine the scrap value when an asset is no longer useful.
The owner will also need to know the market value of the assets he wants to sell. How much money is his assets worth in the current market, and what would people offer for them?
Finally, after the owner has determined his market value, he will subtract that from his liabilities to figure out a rough estimate of the liquidation value.
Now, he will know the liquidation value, but he should consider that it only involves a few other factors; he should not decide whether to sell only based on this valuation.
Limitations of Liquidation Valuation
Like the other valuation methods, the liquidation value method does not account for many factors. It does not capture the company’s worth. Additionally, it cannot assign any value to intangible assets that don't have an instant, comparable value in a nearby market.
What the valuation does best is give the business's creditors valid information they can use. Potential lenders can also use this approach to assess a company's creditworthiness for future financing.
Many start-up companies have many intangible assets, which are not measured when using this valuation, and worldwide companies have slogans and brand loyalty that are intangible assets.
So with the liquidation valuation, such things would not be referred to, thus making it not accurate.
In addition, the major problem with valuation uncertainty is that the company's value is an estimate of the most likely point among a range of potential outcomes based on assumptions established during the valuation process rather than a fact.
So one business can value itself highly and push its liquidation value higher than a buyer would see the business. This is a major issue because liquidation can be calculated and estimated with many different tools, which do not give a precise number.
Conclusion
The "liquidation value" is the monetary worth received from selling an investment or liquidating a project or business.
The liquidation prices are largely based on subjective estimates made by the evaluator. The assets' physical state will impact values.
Knowing a company's liquidation value is necessary to make better financial decisions.
The value of the assets after they are liquidated will almost always be lower than the book value, but they will be higher than the salvage value because the assets still have some life span and thus have value.
The assets are sold at a loss only because the business needs quick cash. It is very important to note that this value is often only used to see a rough estimate of what the business would get in case of bankruptcy or if it were to sell unexpectedly.
Only using the liquidation value to assess what a business is worth can be misleading. Therefore, analysts use various financial tools.
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