Liquidation definition
/What is Liquidation in Accounting?
Liquidation is the process of selling off the assets of an entity, settling its liabilities, distributing any remaining funds to shareholders, and closing it down as a legal entity. This situation may arise when the partners in a business are no longer willing to run it and have no buyers for the business; in this case, the liquidation process is completed in an orderly manner, sometimes over an extended period of time, in order to maximize the value of the firm’s assets.
The liquidation process is also a possible outcome of bankruptcy, which a company enters when it does not have sufficient funds to pay its creditors. A bankruptcy filing can be voluntary or involuntary. A petition to liquidate a company can be made to the applicable court by creditors who have not been paid by the company; if granted, the business will involuntarily enter bankruptcy.
Liquidation Order of Preference
If a business is being liquidated due to bankruptcy, then the funds raised are first used to pay creditors; if there is any cash remaining after creditors have been paid, the residual amount is distributed among the shareholders. The order of preference for being paid when an entity is liquidated (known as the priority of claims) is as follows:
Secured creditors (senior position)
Secured creditors (junior position)
Holders of preferred stock
Holders of common stock
Related AccountingTools Courses
The price received for a company's assets can be lower than expected if the sale is conducted on a rush basis. This is because the seller does not have sufficient time to locate the largest possible pool of potential buyers, so that the few buyers contacted can bid lower and still expect to achieve the winning bids. Consequently, a common outcome of liquidation is that no residual funds are left over to pay stockholders. This may also mean that there is not enough cash left to even pay creditors. If so, the secured creditors are paid first, and a reduced payout plan is used to pay any remaining funds to the unsecured creditors.