Liquidation is the process of selling assets to free up cash. It may also refer to the compulsory liquidation of an indebted business.
When a business is liquidated, the assets are sold and the cash is used to pay its debts.
What does liquidation mean?
Liquidation generally means selling assets for cash. The money goes from being locked up in a thing, to be freely available as liquid cash.
Inventory is a type of asset that’s regularly liquidated in this way. Retailers hold liquidation sales to sell out-of-season inventory, generating cash that they can reinvest into new-season products.
What is liquidation of a company or business?
Businesses liquidate when they shut down operations and sell assets to pay creditors or owners. Companies generally liquidate under one of three scenarios:
- An owner wants to sell their business but can’t find someone to buy it as a going concern
- An owner wants to sell their business but can’t get the right price and is better off selling its assets individually
- A business is unable to pay off its debts and is forced to declare bankruptcy
What happens when a company or business is liquidated?
When a company or business liquidates, operations are stopped and the assets are sold. The cash received from the sale of assets is used to pay off what is owed. A business might owe money to customers, suppliers, employees, subcontractors, government entities, owners, or shareholders. Collectively, the owed parties are called creditors.
If there’s not enough money left after liquidation to pay all the debts, then creditors may have to settle for partial payments or may miss out altogether. An independent administrator decides who gets what. There are specific rules and guidelines for deciding payments. In a bankruptcy, for example, creditors are generally paid in the following order:
- Secured creditors that guarantee loans based on physical pieces of property
- Administrative costs of bankruptcy liquidation
- Employees that are owed wages
- Employee contributions to benefit plans
- Unsecured creditors, such as credit card bills, suppliers, and loans without collateral. Governmental taxes or fines owed get priority treatment
- Shareholders or owners, who only get paid if all other debts are paid
While most countries follow these guidelines, there are variances.
What is liquidation in accounting?
In accounting, liquidation is the process of closing down a business, selling off its assets, paying creditors, and distributing any remaining assets to shareholders.
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.