Liquidation Value Method

An alternative approach to Going Concern Based Valuation when going-concern ability of a business is
being question or doubtful is the Liquidation Based Valuation or use of liquidation value. This chapter
will discuss the concept of this valuation and describe the
situations or scenarios to consider in this valuation.
Liquidation value
It is a value of a company if it were dissolved and its assets were sold individually. It represents the net
amount that can be gathered if the business is shut down and its assets are sold in piecemeal. This is
known as Net Asset Value.
Situations to Consider Liquidation Value
a. Business Failures – low or negative returns are signs of business failures that is why it is the most
common or usual reason why a certain business closes or liquidates.
Types of Business Failures
i. Insolvency, when a company cannot pay liabilities as they become due.
ii. Bankruptcy, when liabilities become greater than an asset balance.

Factors causing Business Failures

iii. Internal Factors – can come from mismanagement, poor financial evaluation and decisions, failure
to execute strategic plans, inadequate cash flow planning or failure to manage working capital.
iv. External Factors – are severe economic downturn, occurrence of natural calamities or pandemic,
changing customer preferences, and adverse governmental regulations.

b. Corporate/Project End of Life – normally, corporations have stated their finite life in their Articles
of Incorporation. If there will be no extension on the corporate life, the terminal value may be
computed using liquidation value.
c. Depletion of Scarce Resources – this is most applicable to mining and oil where availability of scarce
resources influences the value of the firm. Liquidation happens in this business when the permits or
contracts with the government expire and the operation will no longer be allowed to execute.

General Principles on Liquidation Value

1. If the liquidation value is above income approach valuation (based on going concern principle) and
liquidation comes into consideration, liquidation value should be used.
2. If the nature of the business implies limited lifetime (e.g. quarry, gravel, fixed term company etc.),
the terminal value must be based on liquidation. All costs necessary to close the operations (e.g. plant
closure costs, disposal costs, rehabilitation costs) should also be factored in and deducted to arrive at
the liquidation value.
3. Non-operating assets should be valued by liquidation method as the market value reduced by costs
of sales and taxes. Since they are not part of the firm’s operating activities, it might be inappropriate to
use the same going concern valuation technique used for business operations. If such result is higher
than net present value of cash flows from operating the asset, the liquidation value should be used.
4. Liquidation value must be used if the business continuity is dependent on current management that
will not stay.