What is Liquidation?
Liquidation generally refers to the process of selling off a company’s inventory, typically at a big discount, to generate cash. In most cases, a liquidation sale is a precursor to a business closing. Once all the assets have been sold, the business is shut down.
In the accounting world, liquidation refers to the process of selling all of a company’s assets to generate cash to pay off creditors, or anyone the company owes money to.
What Are Assets?
Assets aren’t just inventory, however. Other business assets that could be liquidated include:
- Stores fixtures
- Décor and decorations
- Office equipment
- Packing supplies
- Art and other wall hangings
- Window treatments and rugs
Liquidation sales often occur as part of a bankruptcy filing, but not necessarily. A business could liquidate most or all of its inventory as part of a move to a new location, thereby saving money on having to transport all of it to a new storefront. The biggest downside of inventory liquidation is that, in many cases, the timetable for liquidating assets is short, so the discounts are steep and the cash earned is much lower than the retail value.
Paying Off Creditors
When a company’s assets are liquidated, or converted to cash, the cash is then used to pay off creditors. But there are different classes of creditors that determine in what order they are paid.
The three major classes are:
- Secured – a secured creditor has a lien against the business, or a commitment of assets to repay whatever was borrowed. For example, when a company leases a car, the lender has a lien against the car, so if the business stops paying, the company can take back the car.
- Unsecured – unsecured creditors, such as credit card companies, do not have a lien, or a security interest, in any of the assets, so they are repaid after the secured creditors have been paid.
- Stakeholders – stakeholders are people or organizations that have a vested interest in the success of the business, but no formal claim on the assets. Employees would be considered stakeholders.
As cash is generated from the liquidation sale, creditors are paid in that order.
If a company needs to liquidate its assets quickly, there are businesses that specialize in liquidation. These businesses may buy a company’s entire inventory, or assets, and then sell them to other retailers.
Some liquidators are retailers, too, such as Big Lots, Tuesday Morning, and Ollie’s. These companies buy leftover inventory for a fraction of their retail value and then resell the goods in their own stores, generally for less than the full retail value, but more than they paid for them.