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Business Valuation - The Liquidation Approach
The Current State of Affairs: At the stock exchange, the future is traded. At least that’s what they say, and the conceptual approach is entirely correct. After all, it makes an enormous difference for the shareholder whether a company has generated profits due to one-time effects or if the earning power can be maintained over the years. However, the liquidation approach does not consider what is to come, but rather what is in the current moment.
A simple example:
The fictional company “Machines and Co.” has assets on the active side amounting to 50 million. These consist of the company’s machinery and fleet at 10 million, with another 10 million in the form of inventory, and 10 million in liquid assets. On the passive side, there is 5 million in equity and 45 million euros in. The company is highly indebted. What would the shareholders get in case of liquidation? If one were to liquidate all the assets at this moment, including machinery, fleet, and liquid assets, a total of 50 million would be obtained. After paying off the 45 million in debt, there would be 5 million in equity remaining.
In reality, it is often not as simple to calculate the value of the assets, particularly when it comes to intangible assets, such as the brand name or customer base. Nevertheless, this approach is sensible for simply structured companies.
The Facts:
- There is no “fair” valuation, as future events play a significant role.
- However, the liquidation approach allows for an assessment of the status quo.
- From the liquidated assets of a balance sheet, the debt is subtracted, leaving the capital available for distribution.
- Determining the value of the asset side is where the difficulty of this method lies.
Our Conclusion:
The liquidation approach becomes particularly interesting when companies are in a crisis. The stock market tends to exaggerate in all directions, and with the help of this method, it is possible to at least partially examine whether opportunities arise with a completely devalued asset. However, certain skills in financial statement analysis are necessary to evaluate the relevant data.
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