Liquidation Value vs Going-Concern Value

Liquidation value assumes the business stops and the pieces are sold. Going-concern value assumes it keeps operating. For Sankalp Industrial Systems Limited, an invented manufacturer, orderly liquidation value is Rs 6,20,00,00,000, being Rs 31.00 a share, against a traded equity value of Rs 18,00,00,00,000. The going concern is worth Rs 11,80,00,00,000 more, being 2.90 times the liquidation figure.

Start with a bakery on a busy lane. The arithmetic is easier to feel at that size. There is a deck oven at the back, a planetary mixer, two steel racks, a delivery scooter, a deposit lying with the landlord, and about three weeks of flour and sugar in the store room. The shop has been running for eleven years. The bakery has customers who come on the same day of the week, a tea stall that takes two hundred buns every morning, and a woman who does the accounts on Sundays.

Now ask two different questions about that shop, and watch how far apart the answers land.

The first question is what the shop would fetch if it shut on Friday and everything in it was sold. Somebody comes for the oven. The oven is eleven years old, it has to be disconnected, carried down a narrow staircase, transported and reinstalled, and the person buying it is going to bid on that basis. The mixer goes for less than half of what it cost. Flour and sugar will not keep, so they go quickly to whoever will take them. The scooter fetches what an eleven year old scooter fetches. The deposit comes back in full. Add all of that up, pay off the loan against the oven and the money still due to the flour supplier, and there is a number.

The second question is what the shop would fetch as a shop, with the door open on Monday morning, the tea stall still ordering, and the woman still coming on Sundays. Both questions are about the same oven, the same mixer and the same scooter, and the two answers are not remotely the same number. Nothing physical separates them. The two answers are separated by an assumption about whether the shop is still a shop.

What is liquidation value, and what is going-concern value?

The two answers above have proper names. Liquidation valueWhat the assets would fetch if the business stopped, after every liability is met. is what the assets would fetch if the business stopped and the pieces were sold, after every liability has been met out of the proceeds. Going-concern value prices the business on the assumption that it keeps operating, with the same assets doing the same work next year that they did last year.

Neither value is defined by the arithmetic. Neither is defined by the method, or the discount rate, or the set of accounts the work started from. Each of the two values is defined by the assumption it makes about the future of the business, and everything else is a consequence of that assumption. Once the business is said to stop, the plant is a used machine. Once the business is said to continue, the plant is one link in a system that turns steel into cash every year. The valuation follows the assumption; it does not choose it.

The dependence on an assumption is why the two figures cannot be averaged, blended, weighted or reconciled. The two figures are not two estimates of one thing with some noise between them. Each answers one of two mutually exclusive statements about what happens next, and exactly one of the two statements can be true of any actual company on any actual day.

A going concernA business assumed to keep operating rather than to be wound up. assumption is the ordinary one. A going-concern assumption is what a set of accounts is prepared on, what a lender assumes when it renews a facility, and what anybody quoting a share price is implicitly assuming. The stopped case is the unusual one, and it has to be stated out loud every single time. Once it has been written down as rupees, a figure built on the stopped case looks exactly like a figure built on the ordinary assumption.

What does the word orderly do in orderly liquidation value?

A great deal of work, and it is the word most often dropped when the figure is quoted. An orderly liquidationAn unhurried sale, with time to find buyers. means an unhurried sale. There is time to advertise the plant, time to let a second-hand machinery dealer look at it, time to let the land go through a normal sale process, time to chase the customers who owe money and argue with the ones who dispute their bills. Nobody is standing over the process with a date.

A forced saleA sale conducted against a deadline, with no time to find buyers. is the same disposal conducted against a deadline. The machinery goes to whoever will collect it this month rather than whoever would pay most for it next quarter. The land goes to the buyer who is already in the room. The receivables go to whoever will buy a ledger of disputed invoices at once.

Every liquidation figure below is an orderly figure, and saying so is not a formality: the same assets under a deadline recover less on every line where somebody has to be found to take them. When a liquidation value is quoted without the word orderly in front of it, the first thing to establish is which of the two it is. The difference between them is not small and it is not stated anywhere on the face of the number.

How is a liquidation value built up?

By one rule applied twice, in two opposite directions. Every asset comes in at a recovery rateThe share of an asset's recorded amount that a sale is assumed to realise., meaning some share of the amount it is carried at, and every liability comes off in full. The two directions are the entire method. There is nothing else in them.

The recovery rate is where all the judgement sits, and it is worth being blunt about what a recovery rate actually is. A recovery rate is not a discount for prudence, and it is not a haircut applied because the analyst is being careful. A recovery rate is a claim about how sellable a particular thing is once the business around it has stopped, and the three different rates in this guide differ because the three assets differ in exactly that respect.

Think about it through the bakery again. The landlord's deposit comes back at a hundred paise in the rupee, because a deposit is a contractual amount owed by somebody who is still there. The oven does not, because an oven is only worth what the next baker will pay, and the next baker has to get it out of the building. The flour does worst of all, because flour bought for a shop that no longer exists has to be sold to somebody who was not planning to buy flour that week.

What recovery does each kind of asset get here, and why do the three differ?

Here are the assumptions behind the Rs 6,20,00,00,000, named in full, for Sankalp Industrial Systems Limited. A rupee is a rupee whatever the business is doing, so cash comes in at a hundred per cent. The surplus land parcel comes in at its full current value of Rs 45,00,00,000. The 26.0 per cent holding in Aruna Tooling Private Limited, invented, comes in at its full current value of Rs 55,00,00,000. Receivables come in at 90 per cent. Inventory comes in at 55 per cent. Plant comes in at 40 per cent of bookThe recorded amount of an asset, used here as the base for a recovery rate.. And every liability comes off at a hundred per cent.

Now the reasons. The rates are worthless without them, and a reader who takes them as arbitrary percentages has learned nothing.

Land and the holding in the associate come in whole because both have buyers who do not need this company to exist. A parcel of industrial land is worth what industrial land is worth, and the person buying it has no interest in whether valves were ever made next door. A 26.0 per cent holding in another company is a claim on that other company. Aruna Tooling Private Limited is still trading, still making tools and still worth whatever it was worth on the morning Sankalp Industrial Systems Limited stopped. Neither asset is damaged by the stopping.

Receivables come in at 90 rather than at a hundred because a customer's willingness to pay a disputed line on an invoice changes the moment the supplier stops. While the relationship is live, both sides want next month's order, and an argument about a short-shipped consignment gets settled. Once the supplier has gone, there is no next month's order, and the argument gets a great deal cheaper to have. Some customers will simply take longer. A few will take the position that they were owed a credit note and never got one.

Inventory comes in at 55 because much of it is not general-purpose material. Much of the inventory is work in progress on part-built valves, and much of it is aftermarket spares held for machines that Sankalp Industrial Systems Limited installed at customer sites. Part of what a customer was buying was the certainty that the next spare would also be available, so spares for a company that no longer exists are worth considerably less than spares for a company that will still be answering the telephone in two years.

Plant comes in at 40 per cent of book because a used production line is not a product, it is a project. Somebody has to survey it, dismantle it, transport it, reinstall it, recommission it and then find work for it. Every one of those steps costs money, and a buyer offers the price the line is worth to them after all of it. A line sitting where it is, connected, qualified and running, is worth a great deal more, and the two prices answer different questions.

Why do the liabilities come off at 100 per cent when the assets come in at a discount?

Because they are promises rather than things. An asset has to be sold to somebody, and what somebody will pay is a question about the world. A liability is an amount that was agreed, and it stays that amount whether the sale goes well or badly. The Rs 6,00,00,00,000 of gross debt that Sankalp Industrial Systems Limited carries is Rs 6,00,00,00,000 in a good disposal and Rs 6,00,00,00,000 in a bad one. Nobody renegotiates it downwards because the plant fetched less than expected.

The two treatments together produce the single most important structural fact on the asset side. Assets come in at a discount, liabilities come off in full, and the shareholders are paid last. So the only line in the calculation with any give in it is the one at the bottom, and every rupee that an asset recovery falls short by is absorbed in full by the shareholders.

Absorbing the shortfall is not a special feature of a liquidation. The absorption is the ordinary arithmetic of a residual claimThe claim paid last, which absorbs the whole of any shortfall., the same arithmetic that governs the walk from a firm value to an equity value in the ordinary case, applied to a much less forgiving set of numbers. The size of the discounts is what makes it bite in a liquidation. In the ordinary case the assets are not being marked down by 60 per cent before the lenders are paid.

A concrete instance, and then a refusal that goes with it. Inventory sits at Rs 1,44,00,00,000 in the Year 0 working capital of Sankalp Industrial Systems Limited. If the inventory recovery came in at 45 per cent rather than 55, that is ten percentage points on Rs 1,44,00,00,000, being Rs 14,40,00,000, and the whole of it comes off the shareholders and off nothing else. The lenders are unaffected. Now the refusal: the amounts sitting behind the other recovery lines are not stated, and a total rebuilt from one known line and several unknown ones would be a number nobody could check, so no new liquidation total follows.

How far apart are the two figures for this company?

Far enough that the distance is the subject rather than a footnote to it. Take Sankalp Industrial Systems Limited on one day, under the two assumptions.

Under the assumption that it stops, the orderly liquidation value is Rs 6,20,00,00,000. On 20,00,00,000 shares that is Rs 31.00 a share.

Under the assumption that it keeps operating, what the shareholders' claim actually changes hands for is Rs 18,00,00,00,000, being Rs 90.00 a share.

The going concern is worth Rs 11,80,00,00,000 more than the orderly liquidation, being 2.90 times it. Per share, Rs 90.00 against Rs 31.00, a difference of Rs 59.00 a share. The subtraction and the ratio say different things, so both statements are worth making. The subtraction gives a rupee amount that can be compared with other rupee amounts on the same claim. The ratio shows that the stopped case is a little over a third of the continuing case. A ratio of that sort survives being carried to another company of a different size.

What is the Rs 11,80,00,00,000 between them actually measuring?

The value of the business continuing to operate. Operating value is the entire content of the gap, and saying so plainly is worth more than any further arithmetic.

Look at what sits on each side of the comparison. The same plant. The same land. The same receivables. The same inventory. The same cash. Not a single physical thing differs between the Rs 6,20,00,00,000 and the Rs 18,00,00,00,000. The difference is whether those assets are arranged into something that turns Rs 12,00,00,00,000 of revenue into Rs 2,88,00,00,000 of earnings before interest, tax, depreciation and amortisation (EBITDA) year after year, or separated into items on a disposal list.

The bakery makes this concrete in a way a balance sheet cannot. The oven, the mixer, the racks and the scooter, sitting in a room, are worth what four second-hand items are worth. The same four items, plus a lane, plus eleven years of people knowing what time the bread comes out, plus a tea stall that orders two hundred buns every morning, are worth a great deal more. Nobody paid for the arrangement. The arrangement accumulated. And the entire difference between the two valuations is a price on that accumulation.

The gap is also not several things it gets taken for. A gap is not a measure of anything being mispriced, and it is not a signal about the shares. Every profitable operating business shows a large gap here. A business with no gap at all would be one where the assets are worth as much detached as attached. Very few businesses answer to that description, and no ordinary manufacturer does.

Where does the liquidation figure sit against the other numbers on the same claim?

Below all of them, and it is worth seeing why, because the reader who meets four rupee figures against one company's equity will otherwise assume they are four attempts at the same answer.

Four figures exist for the shareholders' claim on Sankalp Industrial Systems Limited on the same day. Orderly liquidation value is Rs 6,20,00,00,000, being Rs 31.00 a share. Book value of equity is Rs 9,00,00,00,000, being Rs 45.00 a share. At a share price of Rs 90.00 that is a price to book of exactly 2.00 times. Adjusted book value is Rs 11,10,00,00,000, being Rs 55.50 a share. Traded equity value is Rs 18,00,00,00,000, being Rs 90.00 a share.

Book value and adjusted book value are covered separately and are restated here only to place the liquidation figure among them. For completeness, the adjusted figure is book value plus four adjustments and no others.

The column checks: Rs 9,00,00,00,000 plus Rs 33,00,00,000 plus Rs 33,00,00,000 plus Rs 1,50,00,00,000 less Rs 6,00,00,000 is Rs 11,10,00,00,000. The four figures are answers to four different questions, and the ascending order is a consequence of what each question is allowed to assume rather than evidence that the higher ones are more optimistic. The liquidation figure asks what the pieces would fetch if the business stopped. Book value asks what the accounts record. Adjusted book value asks what the accounts would record if certain items were remeasured. The traded figure asks what the claim changes hands for while the business continues.

One trap to name and then step around. A reader who has met the rebuild cost of this company will spot it. The replacement cost of the tangible asset base of Sankalp Industrial Systems Limited is Rs 17,90,00,00,000, sitting within Rs 10,00,00,000 of the Rs 18,00,00,00,000 market capitalisation. The near-equality is an arithmetic accident between two figures that are not comparable. Replacement cost is the cost of an asset base and belongs against the traded enterprise value of Rs 22,40,00,00,000 rather than against what is left for shareholders after the lenders. The rebuild question is covered separately.

Is liquidation value a floor under what a business is worth?

Liquidation value as a floor gets handled carelessly more often than anything else on the asset side, so it is worth being exact.

Liquidation value is very commonly described as a floorA level below which a value is claimed not to go, which holds only under stated conditions. under what a business is worth. The reasoning sounds airtight. Whatever else happens, the business could always be stopped and sold, so it cannot be worth less than what stopping and selling would produce.

Liquidation value is a floor under a very specific and unpleasant assumption, and it is never the value of the company. The assumption is that the business stops. And the moment it stops, the receivables collect worse, the inventory sells worse and the plant fetches scrap-adjacent prices. The stopping is precisely why the three recovery rates above differ from one another and from a hundred per cent. The haircuts are not a general allowance for uncertainty. The haircuts are the direct consequence of the same assumption that makes the floor available at all.

So the sentence has to be finished properly every time it is started. Not "the company is worth at least Rs 6,20,00,00,000". Instead: under the stated recovery rates, in an unhurried sale, with the process costing nothing, the assets net of every liability come to Rs 6,20,00,00,000. The longer sentence is duller and it is correct, and the three qualifications in it are not decoration. Each one is a condition that has to hold.

What has to be true before it is a floor at all?

Three things, and none of the three is a line in any set of accounts. All three are assumptions about the world.

Condition 1, the recoveries have to be achievable

Every recovery percentage above is an assumption made by somebody. Plant at 40 per cent of book supposes there is a market for these machines at that price. In an industry where everybody is selling at once, there may not be one. A missing market is not a remote scenario. Businesses in the same industry tend to come under pressure at the same time, for the same reasons, and the disposal market for specialised industrial plant is thin at the best of times. The recovery assumptions that matter most are exactly the ones that would be worst in the circumstances where a liquidation was actually happening. The floor is weakest at precisely the moment it is being relied on.

Condition 2, the process has to cost what was assumed

A wind-upThe process of stopping a business and disposing of what it holds. takes time and consumes money. Somebody manages it, somebody sells the assets, somebody deals with the customers and the employees and the landlords and the counterparties to every contract the company signed. None of that is free, and nothing in the Rs 6,20,00,00,000 is set aside for any of it. The figure is what the assets realise net of the liabilities, and the cost of realising them is simply not in it. A genuine floor would be the figure less the cost of the wind-up, and that cost is not a line in any set of accounts.

Condition 3, somebody has to be able to stop the business

And this is the one people forget. A floor that requires a decision nobody holding the claim is in a position to take is not a floor for them at all.

Work through who could actually cause a wind-up of Sankalp Industrial Systems Limited. Not a shareholder with a small holding. Not an analyst. Not a person who has read the accounts carefully and concluded that stopping would be better than continuing. A minority shareholder who calculates that the business is worth Rs 31.00 a share in a wind-up has calculated something they cannot bring about, cannot vote into existence and cannot compel. The figure describes a world they have no route to.

Compare it with a fixed deposit, where the holder can walk into the branch and break it. The deposit is a genuine floor for that holder. The action producing it is theirs to take. The liquidation value of a listed manufacturer is not that. A liquidation value is a number about a hypothetical that nobody in the conversation has the standing to make real.

What would a forced sale be worth for this company?

Less than Rs 6,20,00,00,000, and no figure for it is established.

The direction is knowable from the mechanics alone. The recovery on those lines depends on having time to find the person who values the asset most, so a forced sale recovers less on every line where an asset has to be found a new home. The plant is the extreme case: the difference between selling a production line to a buyer who wants that exact line and selling it to whoever will collect it before a deadline is not a rounding difference. Chasing a disputed invoice properly takes months, so receivables behave the same way. Cash does not move at all. The land parcel and the associate holding move least, both having markets deep enough that a deadline costs less.

The amount is not established, and inventing one would put a figure into a comparison that would then be quoted by somebody who no longer remembers where it came from. Repetition is the mechanism by which a made-up number becomes a fact. The number is stated once as an illustration, repeated once without the caveat, and cited a third time as a benchmark. The direction is knowable; the amount is not.

When does this comparison actually matter?

In a narrow set of situations, and naming them keeps the method in its place rather than letting it drift into every valuation.

The comparison matters where a business is actually being wound up. Then the stopped case is not a hypothetical, it is the plan, and every recovery rate is a live question that somebody has to answer with a real buyer.

The comparison matters where a lender is asking what it would recover if things went badly. A lender is not underwriting the upside of the business and never gets any of it, so a lender's question is genuinely a stopped-case question. A lender wants to know the shape of the bad outcome, and the asset side under a stopping assumption describes exactly that.

The comparison matters where a business is loss-making and whether it should continue is genuinely open. If a business is consuming cash rather than producing it, then continuing has a cost, and comparing what it would fetch stopped against what continuing is expected to produce is a real comparison between two real alternatives.

In the ordinary case of a profitable operating company that nobody is proposing to stop, the comparison is an interesting fact and not a valuation. Sankalp Industrial Systems Limited is that ordinary case. The company turns Rs 12,00,00,00,000 of revenue into Rs 2,88,00,00,000 of EBITDA, nobody has proposed stopping it, and its liquidation value describes a world that is not the world the company is in.

What is the sentence that does not follow?

The one that draws a conclusion from the distance between the two figures.

The arithmetic never says that because the liquidation value is Rs 6,20,00,00,000 and the shares are valued at Rs 18,00,00,00,000, anything follows about the shares. The distance is a gap between two answers to two different questions, and it supports no conclusion at all about either of them.

The condition under which the distance would support a conclusion is worth setting out. The two figures would have to be estimates of the same quantity, so that the difference between them was evidence that one was wrong. The two figures are not. One assumes the business stops. The other assumes it continues. The difference between them is not an error term. The difference answers a third question: what continuing is worth. That answer is Rs 11,80,00,00,000.

And the empirical point that finishes it off: every profitable operating company shows a large gap here. The gap is the ordinary state of affairs rather than a finding about this company, and a fact that is true of nearly everything cannot distinguish anything.