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Liquidation Diligence and the Importance of Acting Quickly

By Steve Jones

When the economy is down, bankruptcies are up. Consequently, as protection against the impending costs associated with this increased risk, lenders should be focusing their attention not only on the quality of collateral, but also on just how liquid the collateral offered by their debtors really is. With stagnant business growth, certain assets may be harder to sell, and what once took days to trade may now take weeks, incurring unexpected and sometimes devastating expenses along the way. As financial institutions evaluate collateral, one simple, important, yet often over-looked fact to keep in mind is how long it will take to liquidate.
Real estate – If the building and grounds have not been appraised within the last 12- to 18-month period, the value attributed to it is most likely incorrect. In addition to the potential of an overvalued asset, possible roadblocks associated with real estate liquidation exist, especially in today’s market, where we are seeing property remaining on the market longer and longer. During this time, the lender incurs costs from numerous sources, such as real estate taxes, insurance and utilities costs as well as regular upkeep and maintenance – not to mention broker fees. These expenses can quickly erode any expected earnings from the sale.
Accounts receivable – What could be simpler? Someone owes the business money; all the lender has to do is collect it, right? In reality, accomplishing this takes time, and while these accounts remain open there are employees to compensate, computer systems to maintain and records to keep, all of which reduce the cash received on the accounts receivable collateral.
Company vehicles – Cars, trucks and vans lose value fairly quickly. Depreciation is a major concern with this type of asset, as sales prices can plummet even during the liquidation period. Consider whether the values attributed are up to date and how long it may take to move these assets should liquidation occur. In addition to additional depreciation on these vehicles during the liquidation process, there are other costs, such as insurance costs to consider. Be cognizant of the location of these vehicles as the more dispersed the company’s fleet is, the more it will cost to ship the vehicles to a centralized location for auction.
Machines and equipment – Although companies may have relatively new pieces of machinery on their books with reasonable net book values, the costs associated with dismantling and relocating this equipment must also be considered. Another consideration sometimes overlooked is the fact that machinery is often specialized and may have been customized for the company’s unique needs. This factor may significantly reduce the target market and ultimately the liquidation value of the equipment.
Inventory – The key thing to consider here is simple: How quickly can the inventory be sold? Of course the primary sources are the company’s current customers; unfortunately most of the time these customers will only be able to purchase or acquire a portion of the product on hand. The total current supply in these cases exceeds the customers’ immediate demand, which makes selling inventory a time-consuming process. Employees must be retained and paid, which calls for all applicable employer taxes, health care costs, etc. There are additional costs associated with storing and transporting the inventory. Also remember that the longer these items sit on the shelf, the higher the risk of their obsolescence.

The Tip of the Iceberg
This is not meant to be an all inclusive list of assets and their associated risks during liquidation. This should, however, serve as a reminder to lenders that there are very real costs connected with the length of time it takes to liquidate collateral. Lenders vigilantly focus on the quality of the collateral, appraisals, obtaining third-party support and accounting documentation to verify a company’s asset value; many times, however, little to no consideration is given to how long it will actually take to liquidate a company – and how costly a prolonged liquidation process can become.
Even with the most attentive and meticulous screening of loan applications in place, the risk of debtors going into default and, ultimately, bankruptcy is very high today. Carefully examining collateral values with an eye toward the often unexpected expenses that may occur during liquidation can make a big difference to the security of your funds. If you do not have capabilities in-house to conduct investigations of this depth, or if you feel your organization could benefit from an informed second opinion, consider reaching out to a knowledgeable auditing specialist with experience in this area. 

Steve Jones is a senior audit manager at Moody, Famiglietti & Andronico, LLP.

Posted on Thursday, December 29, 2011 (Archive on Wednesday, March 28, 2012)
Posted by Scott  Contributed by Scott


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