What it means
Liquidation value answers a specific question: what is the floor under this company's worth? It ignores brand, customer relationships, trained staff and future profits, and counts only what the physical and financial assets would fetch if sold, minus what is owed.
The gap between liquidation value and going concern value is usually large, and the reason is that a working business is worth more than the sum of its parts. A profitable bakery is worth its ovens plus its customers plus its recipes plus its team; a liquidated bakery is worth its ovens, at second-hand prices.
Calculating it means applying a recovery rate to each class of asset rather than accepting book values. Cash recovers at 100%, receivables typically at 70% to 85%, inventory often at 40% to 60% depending on how sellable it is, and specialised equipment sometimes at 20% or less.
There are two versions worth distinguishing. Orderly liquidation value assumes a reasonable marketing period of several months and produces higher recoveries; forced liquidation value assumes an auction within weeks and produces much lower ones, and lenders normally use the forced figure.
The number matters most to people who might not get paid. Secured lenders use it to size a loan against collateral, distressed investors use it as the downside case when buying a struggling company, and boards use it as a sanity check when deciding whether continuing to trade is genuinely better than stopping.
In practice
Real-world examples.
Example
A bank lending against a distributor's inventory advances only 40% of its cost value, because that is roughly what the stock would fetch in a forced sale. The borrower sees a conservative advance rate; the lender sees a loan comfortably covered by liquidation value.
Example
A private equity buyer assessing a loss-making components maker calculates a liquidation value of $2,800,000 and uses it as the price floor in negotiations. Anything paid above that is a bet on turning the business around.
Example
A board reviewing a subsidiary that has lost money for four years compares a liquidation value of $1,200,000 against a rescue plan needing $2,000,000 of fresh funding. The comparison makes the closure decision far easier to argue.
Formula
Calculation
Liquidation value = sum of (asset book value x its recovery rate) - liquidation costs - total liabilities.
Consider Brayton Tool Company. Its assets and estimated forced-sale recovery rates are: cash of $200,000 at 100%, giving $200,000; receivables of $800,000 at 75%, giving $600,000; inventory of $1,000,000 at 45%, giving $450,000; and equipment of $1,500,000 at 30%, giving $450,000.
Gross realisation is $200,000 + $600,000 + $450,000 + $450,000 = $1,700,000. Liquidator fees, legal costs and site clearance are estimated at $200,000, leaving $1,500,000. Total liabilities are $1,100,000, so the liquidation value of the equity is $1,500,000 - $1,100,000 = $400,000.
Compare that with the balance sheet. Book assets total $200,000 + $800,000 + $1,000,000 + $1,500,000 = $3,500,000 and book equity is $3,500,000 - $1,100,000 = $2,400,000. The liquidation value of $400,000 is about one sixth of book equity, which is the sort of gap that surprises owners the first time they see it.Case study
Seen in the real world.
Quillon Textiles is a fictional mill created to illustrate how liquidation value is used in practice. Its balance sheet showed $6,400,000 of assets and $2,900,000 of debt, implying book equity of $3,500,000, and the family owners assumed a sale would fetch something close to that.
An adviser ran the recovery-rate exercise. The dye equipment was highly specialised and valued at 20% of book, the yarn inventory at 50%, and the receivables at 80%, which together with liquidation costs produced a liquidation value for the equity of roughly $450,000.
The number changed the conversation entirely. Rather than holding out for a price near book value, the owners negotiated a sale to a competitor at $1,600,000, comfortably above liquidation value and well below book, and this illustrative example shows why the floor is worth knowing before you start bargaining.
Watch out
Common mistakes.
- Using book values as liquidation values, when carrying amounts assume the business keeps trading and reflect original cost less depreciation, not resale demand.
- Forgetting to subtract the costs of liquidating, including liquidator fees, legal work, redundancy payments and site clearance.
- Treating goodwill and other intangibles as recoverable, when brand value and customer lists usually evaporate the moment a business stops trading.
Questions
People also ask.
Is liquidation value the same as book value?
No, book value follows accounting rules while liquidation value estimates real forced-sale proceeds, and the two rarely match.
Can liquidation value be negative?
Yes, and it commonly is; if realisations plus costs fall short of liabilities, the owners have nothing and creditors take a shortfall.
Why do lenders care about liquidation value?
Because it estimates what the collateral would actually cover if the borrower failed, which is what sets sensible advance rates.
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