Liquidation Value Method

Liquidation Value Method

The Liquidation Value Method is used to estimate the value of a company if it were to be liquidated, meaning all assets are sold, and liabilities are settled. It is commonly used in distress scenarios, bankruptcy proceedings, and conservative valuation approaches.

Step 1: Identify and Categorize Assets

List all the company’s assets based on the balance sheet. These typically include:

  1. Current Assets

    • Cash & Cash Equivalents
    • Accounts Receivable (adjusted for doubtful debts)
    • Inventory (adjusted for obsolescence)

  2. Fixed Assets (Property, Plant, Equipment - PPE)

    • Machinery & Equipment
    • Land & Buildings
    • Vehicles

  3. Intangible Assets (if applicable)

    • Patents, trademarks, and brand value (these are often excluded in a strict liquidation scenario unless they can be sold)

  4. Other Assets

    • Investments in subsidiaries
    • Long-term deposits

Step 2: Determine Realizable Value of Assets

Each asset class must be adjusted to reflect liquidation value, which is usually lower than book value. There are three common valuation approaches:

  1. Forced Liquidation Value (FLV)

    • Assets are sold in a short period (distressed sale).
    • Typically results in low recovery values (e.g., 20-50% of book value for inventory).

  2. Orderly Liquidation Value (OLV)

    • Assets are sold over time to maximize proceeds.
    • Recovery rates are higher than FLV (e.g., 70-90% for fixed assets).

  3. Fair Market Value (FMV)

    • Used if the company is not in distress but is considering asset disposal at market rates.

Example Adjustments

Asset Type Book Value Recovery Rate (%) Liquidation Value
Cash & Equivalents $5M 100% $5M
Accounts Receivable $10M 80% $8M
Inventory $15M 50% $7.5M
Machinery & Equipment $20M 70% $14M
Land & Buildings $30M 90% $27M

Step 3: Identify and Subtract Liabilities

List all outstanding obligations, including:

  1. Current Liabilities

    • Accounts Payable
    • Short-term debt
    • Accrued expenses

  2. Long-term Liabilities

    • Bank loans and bonds
    • Lease obligations
    • Employee severance liabilities

  3. Contingent Liabilities (if applicable)

    • Legal claims
    • Environmental cleanup costs

Example Calculation

Liability Type Amount
Accounts Payable $8M
Short-term Loans $12M
Long-term Debt $25M
Other Liabilities $5M
Total Liabilities $50M

Step 4: Calculate Net Liquidation Value

Net Liquidation Value=Total Liquidation Value of Assets−Total Liabilities\text{Net Liquidation Value} = \text{Total Liquidation Value of Assets} - \text{Total Liabilities}

Example Calculation

  • Total Liquidation Value of Assets = $61.5M
  • Total Liabilities = $50M
  • Net Liquidation Value = $61.5M - $50M = $11.5M

Step 5: Interpret the Results

  • If Net Liquidation Value is positive → Investors, creditors, and shareholders may recover part of their investment.
  • If Net Liquidation Value is negative → Creditors may not be fully repaid, and shareholders may receive nothing.

Step 6: Sensitivity Analysis (Optional)

  • Test different recovery rate assumptions (conservative vs. optimistic).
  • Analyze contingent liabilities and legal risks that could affect liquidation value.