What Does Liquidate Mean?

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Definition:

Liquidate means to sell something for cash, i.e., to turn non-liquid assets (stocks, real estate, etc.) into liquid cash.

🤔 Understanding liquidation

Liquidate means to turn non-liquid assets, like stocks, bonds, real estate, etc., into cash. The term is most commonly used when a business is going bankrupt and selling all its assets or when an investor or trader sells off a specific position (or less commonly, their entire portfolio). In the former, the liquidation of a business’s assets is usually carried out to cover its debts. When it comes to investing, liquidation doesn’t always mean something negative — Investors may choose to liquidate their positions both to lock in profits or to cut losses.

Example

Let’s imagine that Ron bought 50 shares in an imaginary company called Rex Enterprises at $10 per share for a short-term trade. At the start, Ron’s position is worth $500, and it is completely illiquid — Ron can’t use his shares to buy a sandwich at the deli, for example.

After a while, the price per share increases to $11, bringing Ron’s total position value to $550. At that point, Ron decides to liquidate his position, i.e., sell it for cash. Ron makes $50 in profit (minus trading fees, etc.), which he can now use to buy the sandwich he was eyeing.

Takeaway

Liquidating assets is kind of like turning a bar of metal into quarters...

The bar of metal has value, and you can potentially turn it into quarters, but if you tried to pay your parking meter with a big bar of copper alloy, you wouldn’t get very far. Similarly, when you have illiquid assets, such as stocks, bonds, real estate, etc., you have a lot of potential cash value, but if you tried to buy a TV set with the deed to your house, you’d get laughed out of the store. To make use of the value stored in those assets, you need to liquidate them — convert them into cash by selling them.

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What does liquidate mean?

Liquidate means to convert non-liquid assets (real estate, ETFs, stocks, etc.) into cash by selling them. The term is most commonly used in two contexts: a business going bankrupt and selling off all its assets, or an investor or trader exiting a position.

Although non-liquid assets have value, they can’t be used to purchase products or services directly — You can’t show someone your stock portfolio and expect them to accept that as payment.

For those assets to mean anything on a practical level, they need to be converted into cold, hard cash. And for that to happen, a buyer and seller must agree on the precise value of the assets.

Why is liquidation important?

If non-liquid assets have value, why can’t they be used to make purchases? The reason for this is two-fold. First, we live in a money-based economy, not a barter and trade economy. In our society, cash is king, and businesses generally don't accept an offering of, say, 10 bushels of wheat in exchange for their goods anymore.

Even though other financial assets have value, they need to be translated into the common language to become universally understandable — Everyone understands the value of $10, but not everyone can accurately value wheat or real estate. Cash is the middle ground between all assets, be it cheeseburgers or bungalows.

Second, before an asset is liquidated, its price is still in flux. Think about how the stock market works: one minute, a stock could be worth $100 per share, and the next minute it might be worth $90.

Buyers and sellers are constantly negotiating over the correct valuation of any given stock. If you were to try to pay for your lunch in stocks, you could end up paying more or less than your bill from one minute to the next.

Liquidating assets solves both of these issues. It locks in a specific price that everyone can agree on, which keeps the economy moving fluidly.

Without liquidations, every transaction would require bartering until the buyer and seller agreed on an asset’s value — not a very efficient way to run a global economy. Liquidation restricts bartering to very specific markets such as the real estate market, stock market, bond market, etc.

What does it mean to liquidate assets?

Liquidating assets simply means to turn financial assets into cash by selling them. However, it’s typically used to describe businesses or individuals that are in the process of filing for bankruptcy when they can no longer pay back their debts.

It is usually a process that is instigated when a business is shutting down and needs to sell off its property.

Asset liquidations commonly occur during bankruptcy, a legal proceeding in which courts determine whether people or businesses can receive relief from their debts.

One common type of bankruptcy is called a Chapter 7 bankruptcy, aka a “liquidation bankruptcy.” In this kind of bankruptcy, a court-appointed trustee or liquidator takes ownership of an individual’s or a company’s assets and sells (liquidates) them for cash. The proceeds are then used to help pay back debts.

What are the types of liquidation?

Liquidation can either refer to the liquidation of assets in a trade or investment or the liquidation of assets when a business is closing down.

In the first context, it simply means selling off an investment or asset. For example, if you own a house and want to sell it to purchase a new one, you’re liquidating that asset. If you have a few hundred shares of a stock, you may want to liquidate those shares to lock in your profits in cash — or cut short your losses.

In the latter context, liquidation refers to the sale of all a company’s assets when it's closing down. This may include selling furniture, equipment, machinery, office supplies, and real estate. Basically, everything goes.

Although liquidation is typically associated with bankruptcy, that’s not always the case. No matter what reason a business shuts down for, it will usually liquidate its assets.

If it’s liquidating due to bankruptcy, it will use the proceeds to pay off accounts receivable (unpaid bills), creditors, and any other debts. If the liquidation is for more benign reasons, such as a small business owner retiring, the profits from the liquidation may be pocketed by the business owner.

What is the liquidation process?

The liquidation process depends on the situation. When voluntarily selling stocks, real estate, or other similar assets, a buyer and seller will simply negotiate a price (the market price), the buyer will give the seller cash, and the seller will give the buyer the asset. Often there will be an intermediary such as a real estate agent or broker to assist in the process.

When it comes to liquidating business assets due to Chapter 7 bankruptcy, the process is slightly more involved. First, the business will need to file for bankruptcy, a legal proceeding that helps debtors get relief from debts they can’t pay back.

To initiate that process, the business must undergo credit counseling within six months of filing (exemptions for this step are available if no approved counselors are in the area).

Then, the business will need to fill out forms with detailed financial information about its assets, revenue, expenses, etc.

After the process is initiated, the court will assign a trustee to sell off all the business’s assets. Once all the assets have been sold, the proceeds will go to pay off outstanding debts. Any debts that remain will be relieved (canceled).

When do companies liquidate assets?

Companies typically liquidate assets under two circumstances: when they are voluntarily closing down and when they are filing for Chapter 7 bankruptcy.

Businesses close down for all sorts of reasons — sometimes, the owner has simply had enough and wants to retire. No matter the reason for the shutdown, the business will liquidate its assets (ideally for a profit) as it no longer has a use for them.

Think of it like a yard sale — You don’t keep all that old junk you’re not using forever. Instead, you sell it and use the money for something else. Similarly, businesses liquidate all their assets when they close up shop to get rid of what they don’t need and recoup some of their investments.

However, sometimes businesses liquidate their assets to pay back debts they can’t afford in a process called bankruptcy. In this case, the asset liquidation is mandated by the court, and a trustee is assigned to help the business sell off all its assets.

What does it mean to liquidate a stock?

Liquidating a stock means selling it for cash. The price of a stock is continually fluctuating based on market conditions, which makes it unusable for daily transactions — just try paying for lunch with a share of Johnson & Johnson. To make it usable, stockholders need to sell it, i.e., liquidate it, to lock in its value.

When a stock is liquidated, a buyer and seller agree on a price, the buyer pays the seller, and the seller transfers the stock to the buyer. Now, the seller has cash that they can use to buy other products, services, or financial assets.

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Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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