The Liquidation ApproachThe liquidation approach is one of the primary business valuation methods available. It is used when the company is determined to no longer be a going concern and liquidating the assets would yield a higher value than the present value of its future earnings and cash flow potential.
The final after tax proceeds available from a liquidation approach requires that all assets and liabilities in a balance sheet be assessed. The net realizable value of the assets minus the disposition costs is first estimated.
New Realizable ValueThe net realizable value (NRV) of the assets may include the following components:
- Marketable securities at present value minus disposition costs - this would include today’s value of any stocks, treasury bills, and other investments that the company has. Disposition costs such as broker commissions or early redemption penalties need to be subtracted to determine the marketable securities’ NRV.
- Accounts receivable - the NRV of accounts receivable would be based on what is likely to be collected in the immediate future. If there are any bad debts or customers that may be in financial difficulty, then these receivables would not yield any value. A simple way to assess the NRV of existing receivables is to sell them to a company and use the price provided as a floor to assess their value.
- Inventory at resale - there are essentially three kinds of inventory: raw materials, work in progress, and finished goods. For raw materials and finished goods, the NRV would be the value expected to be realized minus selling costs of the inventory sold either individually or altogether. For work in progress, you need to determine if the inventory would yield a higher value as is or after it is finished appreciating that finishing it would likely mean some costs incurred.
- Prepaid expenses - these would be assumed as if realized into cash. For example, if there is insurance that has been prepaid for the year, the amount left for the year (say six months) would be its cash value.
- Real estate - would be valued at the current market price net of selling costs which would include commissions and legal expenses.
- Operating assets - equipment, furniture, fixtures would be assumed sold as is in an auction either on a piecemeal or enbloc basis. The net book value of these assets is not generally representative of NRV that can be achieved, so taking them to the auction would be the only way to determine their real value.
- No value assets - assets on the balance sheet such as leasehold improvements and intangibles are not assigned any value under the liquidation approach.
SubtractionsFrom this balance, you would need to consider subtracting the following costs unique to the liquidation of a company:
- Professional fees including a receiver, legal, and final accounting and tax advise
- Severance payments to your employees and any vacation pay that is owed to them
- Shutdown and mobilization costs which include cleaning the equipment and getting it ready for sale as well as transporting it to the sale
- Outstanding commitments which would include any obligations under contracts that still need to be met
After subtracting liquidation costs from NRV, the proceeds would have to be tax effected before computing the final proceeds on sale using the liquidation approach. The tax effect would depend on the country and state where the company is located, but typically the following matters would be considered:
- Any tax due on capital gains realized on the sale of investments and marketable securities
- Any tax due on capital gains realized on the sale of fixed assets
- Tax due or refundable on the recapture or terminal loss of tax depreciation
- Any refundable taxes available to the shareholders (in some countries such as Canada, 26.67% of the taxable capital gain is refundable to shareholders if dividends are paid).