Liquidation analysis is an accounting term that refers to the piece-by-piece value of a company or asset upon sale (liquidation) under normal market conditions. This analysis can be used to determine a base price for a company acquisition or insurable value for construction purposes. Accountants, bankers and investors alike use this calculation as a necessary component of a company's valuation.
Sum of Parts
Investment managers and company analysts are the most common users of liquidation analysis. These managers analyze what each component asset is worth in a sale or liquidation and sum them to get a true value for the company. For example, in 2011 Motorola split into two divisions called Motorola Mobility and Motorola Solutions, which are focused on the consumer and enterprise space respectively. Once the companies split and went public independently, the total value differed from the original company.
In chapter 7 bankruptcy, the true liquidation value is determined due to the fact that all of the assets are sold to pay off creditors. However, this value is actually lower than the individual total value because buyers know that the assets must be sold in a limited time period. Assets are said to be "impaired" or of lower value and bidders can keep the price down. It is the responsibility of the judge assigned to the bankruptcy proceedings to approve a sale with the highest proceeds possible.
Reconstruction value takes into account the actual cash value to replace the asset (usually a property) but is less than the market value, because it excludes the land. This value is computed for every property in case of fire, water or wind damage that would require replacement for insurance purposes. The major components of this value are the materials and construction costs as well as assets within the property.
Liquidation Value vs. Book Value
The book value of a firm includes all of the assets of a company plus the cash and marketable securities. In some cases, the market value of a company is below the book value of a firm. This occurs when investor sentiment gets extremely pessimistic about a company's future. However, in these cases, the liquidation value is above the market value and is a great investment.
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