Liquidity is the ease of converting tangible assets into cash and it has different connotations for different situations and contexts. However, in general, high levels of liquidity give more flexibility to an investor or company to meet their financial obligations. In addition, high levels of liquidity means less risk because the existing assets...
Net tangible assets represents the amount of physical assets minus the liabilities present in a business. The calculation takes the difference between the fair market value of tangible assets (cash, accounts receivable, inventory, capital assets, etc) less the fair market value of all liabilities (accounts payable, debt, etc). Net tangible assets exclude intangibles such as goodwill.
The level of net tangible assets in a business impacts the price that a potential buyer is willing to pay for two reasons:
Let's consider two examples. Two companies are both valued at $2 million based on their estimated future cash flows. Company A has net tangible assets of $1.5 million, and Company B has net tangible assets of $0.5 million. It is easier for an acquirer to obtain acquisition financing for Company A, because the business has significantly more assets to provide as security to a bank. Company A also presents less risk since there is a higher asset base available to liquidate if the company ever becomes insolvent.
A business owner in a capital intensive business should be aware of situations where the future cash flows generated by the assets do not justify their book or "appraised" value. For example, take a business that has net tangible assets of $5 million, but only generates future cash flows to justify a valuation of $4 million. In this case, to maximize value, the business owner should liquidate the assets rather than sell the business as a going concern.
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