What is Liquidation Value and How it is Calculated

Liquidation value is a rarely used methodology or approach in companies or projects, where the cash flow deteriorates. Breakup value is another term, which can be used interchangeably with liquidation value, and it is referred to as the cash value of single asset. The value of this single asset is much lower than the fair market value because, the asset is sold at insufficient time in the market, as the illiquid assets like real estate need a sufficient time to get its fair market value.

What is Liquidation Value?

Liquidation value is basically the total worth of the physical assets of company, when it goes out of business. It is one of the main premise value in determining the business's value. According to Black's law dictionary, its value is defined as "the value of a business or of an asset when it is sold in liquidation, as opposed to being sold in the ordinary course of business." Liquidating a business is done involuntarily, if the company falls into bankruptcy or it may be voluntary, if the owner of the firm is interested in the going-concern value of the company. The going-concern value of a company is a firm's value as an ongoing entity in the excess of the sum of the value of its parts. Business analysts calculate the liquidation value of a company, to find out the minimum value of the company during business failure and liquidation. Investors of a company, use it to find the details of the company in which they have invested. The value investors, who are interested to know whether the stocks they have purchased is profitable or not, will require the concerned company's market capitalization value and the going-concern value of the firm to make their calculation.

Types of Liquidation Value

The International Glossary defines it as "the net amount that can be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either orderly or forced."

Orderly Liquidation Value
Orderly liquidation value is defined as "liquidation value at which the asset or assets are sold over a reasonable period of time to maximize proceeds received". It is also known as voluntary liquidation value. Voluntary liquidation occurs when some important person of a company resigns or if the shareholders vote against the company, and decide not to continue any operation further with the company.

Forced Liquidation Value
Forced liquidation value is defined as "liquidation value at which the asset or assets are sold as quickly as possible, such as at an auction". It occurs when the account of company reaches the under-margin level, and if the company owner is not taking measures to meet the required margin levels, the broker has the right to sell out the positions.

Calculating the Liquidation Value

Liquidation Value = Total Assets - Total Liabilities

Total Assets

• Cash
• Fixed assets such as building, land, machineries
• Receivables
• Inventory

Total Liabilities

• Loans
• Mortgages
• Accounts payable
• Deferred revenues
• Accrued revenues

Liquidation value is calculated in order to estimate the amount of money left after all the assets are sold and the company has paid off the liabilities. For example, real estate is an important asset in a corporate company's balance sheet. Intangible assets such as a company's intellectual property, brand-name recognition, goodwill value, patent, copyrights, trademarks, etc., are not included while calculating the liquidation value of a company. But if the company is to be sold due to financial crisis or bankruptcy, then the liquidation value and value of the intangible assets, will be considered, in order to find the going-concern value of the company, but if the company is liquidated, intangible assets won't be taken into account.

The liquidation value will be less than the retail value and the book value because, liabilities are subtracted from it. According to an article in the magazine named Journal of Finance, "When a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times." This means that, the state of the market during liquidation also determines the liquidation value.