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How to Determine Liquidation Value Method

Liquidation value is the amount of cash that a business can receive for all of its assets including goodwill, property plant & equipment, land, inventory, AR, etc if it were to go out of business tomorrow. For instance, if a business has assets whose fair market values are $500,000 but if it was to go out of business tomorrow and sell all assets, it might only get $420,000. The liquidation value in such a case will be $420,000. In a business that is in a growing & profitable industry, the liquidation value is less than the corporation's current stock price. However, if the business or the industry it is operating in is dying, then the liquidation value will be higher than the stock price. There are 2 methods to liquidation value, and each is explored below:

As the name suggests, distress is when the business must be sold in an emergency to be able to pay off creditors & other debtors, or the business has filed for bankruptcy. Distress liquidation says the business must be sold ASAP to one or more buyers, depending on their bids. In such a scenario because cash is required urgently, the business is usually sold for much cheaper than its fair market value. Think of distress liquidation value as a foreclosure on a home, the buyer cannot afford to keep up with the mortgage and thus the home is foreclosed.

Orderly liquidation is the better of the 2 options and occurs when the assets are auctioned off to buyers and the person with the highest bid wins the assets. Orderly liquidation value takes in to account that the seller has ample of time to market its business, find prospective buyers and sell the business for the highest price possible.

Liquidation value in the real estate industry refers to the most likely price a piece of real estate will sell for if it meets all of the following conditions:

  • The buyer is acting in his/her best financial interest
  • Buyer is motivated
  • Buyer is acting with knowledge of the property
  • Limited time will be available to complete the sale
  • The amount of marketing done to sell the real estate piece will also be limited.
  • Seller is motivated to sell
  • Price accurately reflects the fair market value of the property and is not affected by any creative financing/mortgages offered by the seller or his agent.

This is a creative term that pretty much means the owner's equity in the business is used to decide on the price of the business. The formula for Owner's equity is:

Owner's Equity = Assets - Liabilities

This is also our double-entry accounting formula. For instance, if a business has $500,000 worth of assets but also has $320,000 worth of short/long term liabilities, then the equity in the business will be:

Owner's Equity = Assets - Liabilities

Owner's Equity = $500,000 - $320,000

Owner's Equity = $180,000

The purchase price of the business will therefore be near the $180K mark.