Definition
Liquidation in finance refers to the process of closing a business, selling off its assets, and using those funds to pay off creditors. This usually happens when a company is insolvent and unable to meet its financial obligations. The leftover funds from liquidation, if any, are then distributed to shareholders.
Key Takeaways
- Liquidation refers to the process of bringing a business to an end and distributing its assets to claimants, often seen when a company is insolvent. It’s the means to pay off creditors, shareholders, and investors.
- Different types of liquidation exist. Voluntary liquidation happens when the company’s shareholders decide to dissolve the company due to reasons such as lack of profitability. Mandatory liquidation, on the other hand, is usually enforced by the court when a company fails to pay its debt.
- The liquidation process is handled by a liquidator, who sells the company’s assets, pays off the creditors and disburses the remaining assets to the shareholders (if any). This process follows a particular hierarchy, with secured creditors usually being paid first.
Importance
Liquidation is a crucial finance term as it refers to the process of selling off a company’s assets to generate cash for the purpose of paying off liabilities or debts.
This concept is significant because it ultimately determines the financial stability and sustainability of a company.
In times of financial distress or when a company is bankrupt, liquidation ensures that creditors are paid off to the greatest extent possible.
It can also be seen as a last resort strategy for businesses which cannot meet their financial obligations.
The understanding and efficient handling of liquidation can save investors, creditors, and employees from total loss, and may sometimes allow a business to start afresh.
Explanation
Liquidation is often the final step in the cessation of any business; its primary purpose is to ensure that all of the company’s assets are fairly divvied up and its liabilities paid off. The process involves selling off all the business’s assets and using the proceeds to settle as much of its debts as possible. Any remaining funds, after all debts are paid, are then distributed amongst shareholders, if there are any.
Notably, in legal order, typically, secured creditors, unsecured creditors, and finally shareholders, are paid. Liquidation can be voluntary or involuntary, and while it can signal financial distress or bankruptcy, it might also be a strategic move made by a solvent company. For instance, a company may opt to liquidate a particular business line or unit that’s not performing well, freeing up capital to focus on more profitable areas.
In bankruptcy scenarios, liquidation stands as a last resort. When a company can no longer sustain its operations, liquidation can minimize the financial impact by preventing further loss and liabilities to accumulate. Thus, liquidation serves as a critical tool for financial management and strategy, protecting creditors and limiting losses.
Examples of Liquidation
Toys “R” Us Liquidation: One of the best-known examples of liquidation in recent times is the liquidation of Toys “R” Us in
The famous toy retailer filed for bankruptcy in 2017 due to immense debt and a decrease in sales. The company was unable to find a buyer or restructure its financial situation, so it decided to liquidate its assets. This meant closing all of its 800 stores in the United States and selling its inventory, properties, and other assets to pay off its creditors.
Lehman Brothers Liquidation: Lehman Brothers, one of the world’s largest investment banks, collapsed in 2008 due to its heavy investment in subprime mortgages, prompting the largest bankruptcy filing in U.S. history. Because of its massive debt, the company underwent liquidation to repay its creditors, which included the selling off of real estate, intellectual property and art, and resulted in massive job losses.
Circuit City Stores Liquidation: In 2009, Circuit City Stores, the second-largest electronic retailer in the U.S., filed for bankruptcy protection and decided to liquidate after failing to find a buyer. The company closed its 567 U.S stores and fired more than 30,000 workers. The liquidation lead to selling off its inventory, equipment and other assets to repay their outstanding debts.
FAQs on Liquidation
What is Liquidation?
Liquidation is a process in which a business’s operations are brought to an end, and its assets are divided up. This process is used when a company is insolvent or cannot pay its obligations when they are due.
What are the types of Liquidation?
There are mainly three types of liquidation. The first is voluntary liquidation which is where the shareholders of the company decide to liquidate the company. The second is compulsory liquidation where the court orders the liquidation of the company. The third type is creditors’ liquidation which occurs when the creditors force the liquidation of the company because the company has failed to meet its debt obligations.
What happens during the process of Liquidation?
During the liquidation process, a liquidator is appointed who takes control over the company. Assets are then sold-off, and the proceeds are used to pay off creditors. Any remaining money is then distributed among the shareholders. Once this process is complete, the company is removed from the Companies Register.
What is the difference between Liquidation and Bankruptcy?
Bankruptcy and liquidation are both used to discharge debts. However, liquidation specifically refers to the process of selling off a company’s assets to pay back creditors. On the other hand, bankruptcy is a legal process that either reduces, restructures or eliminates the debtor’s obligations.
What is the role of a Liquidator in a Liquidation process?
A liquidator is a person or entity appointed when a company goes into liquidation who has the responsibility to collect in all the assets of the company, sell them, then distribute the proceeds to creditors in accordance with the legal rules on priority. Once the process is complete, the company is formally dissolved.
Related Entrepreneurship Terms
- Bankruptcy
- Asset Disposal
- Insolvency
- Debt Repayment
- Chapter 7 (U.S. Bankruptcy Code)
Sources for More Information
- Investopedia: A comprehensive online source for finance and investing definitions and explanations.
- Business Dictionary: An online dictionary specific for business and finance terms.
- Corporate Finance Institute: This site offers insights into corporate finance, including concepts like liquidation.
- The Wall Street Journal: A credible news source with many articles related to finance and economics.
