What is the difference between a going concern and liquidation approach?

1 Going concern approach

The going concern approach assumes that the business will continue to operate in the foreseeable future and generate cash flows from its existing activities. Under this approach, you value the business based on its earnings potential and growth prospects. You can use different methods to estimate the going concern value, such as discounted cash flow (DCF), market multiples, or transaction multiples. The going concern approach is suitable for businesses that are profitable, stable, and have a competitive advantage in their industry.

2 Liquidation approach

The liquidation approach assumes that the business will cease to operate and sell all its assets and liabilities. Under this approach, you value the business based on its net asset value, which is the difference between the fair market value of its assets and the amount of its liabilities. You can use different methods to estimate the liquidation value, such as book value, adjusted book value, or liquidation value. The liquidation approach is suitable for businesses that are unprofitable, distressed, or have no growth potential.

4 Difference in multiples

The difference between the going concern and liquidation approaches also affects the valuation multiples and comparables that you use to compare the business with other similar businesses. Valuation multiples are ratios that express the value of a business relative to a financial metric, such as revenue, earnings, or assets. Comparables are other businesses that have similar characteristics and performance to the business being valued. When you use the going concern approach, you should use multiples and comparables that reflect the earnings potential and growth prospects of the business, such as price-to-earnings (P/E), enterprise value-to-EBITDA (EV/EBITDA), or price-to-book (P/B). When you use the liquidation approach, you should use multiples and comparables that reflect the net asset value of the business, such as price-to-tangible book (P/TB), or price-to-liquidation value (P/LV).

5 Difference in scenarios

The difference between the going concern and liquidation approaches also depends on the scenarios and objectives that you are considering for the valuation. For example, if you are valuing a business for investment purposes, you may want to use the going concern approach to estimate the future returns and risks of the business. If you are valuing a business for acquisition purposes, you may want to use the liquidation approach to estimate the minimum price that you would be willing to pay for the business. If you are valuing a business for litigation purposes, you may want to use both approaches to estimate the damages or losses that the business has suffered or caused.

6 Difference in limitations

The difference between the going concern and liquidation approaches also implies different limitations and challenges that you need to be aware of when applying them. The going concern approach requires you to make assumptions and projections about the future performance and growth of the business, which can be uncertain and subjective. The liquidation approach requires you to estimate the fair market value of the assets and liabilities of the business, which can be difficult and costly to obtain. Both approaches require you to select appropriate multiples and comparables that are relevant and reliable for the business being valued, which can be scarce and inconsistent.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?