Both Administration and Liquidation are formal company insolvency (a state where the company is not in a position to settle its debts) practices. The key difference between administration and liquidation is that administration is a business rescue tool that may help the business to survive while a liquidation process is used to close the business down by discontinuing operations.
CONTENTS
1. Overview and Key Difference
2. What is Administration
3. What is Liquidation
4. Side by Side Comparison – Administration vs Liquidation
5. Summary
What is Administration
This is a state of insolvency where the company is unable to pay off its creditors; thus, the management attempts to sell off the company before it goes into liquidation. This can be done through a ‘pre-pack administration sale’. This amounts to selling the company to a prospective buyer or to the existing directors by forming a new company. If the directors have enough funds and the willingness to purchase the company’s assets, then a pre-pack sale may be arranged. The contracts, property, and other assets of the insolvent business are transferred to a newly formed company during this process. Following an administration, the company continues to operate as a business without being terminated.
Through administration, a number of negative consequences such as loss of jobs and negative publicity can be avoided. However, since the business is already insolvent, it is often difficult to find a prospective buyer or the directors may also not be willing to purchase the company.
What is Liquidation
Liquidation is a situation where the company is unable to settle its creditors as and when they are due, and the company is no longer in a position to continue its business operations. Here, the company will pay the creditors by selling off the net assets in the business. The available tangible net assets can be sold for their fair value (the current estimated value at which the asset can be sold in the market) and funds can be generated. However, the principle drawback here is that the business will not be a position to gain any extra funds for its goodwill, which is one of the most important intangible assets. Goodwill is the reputation that adds to its overall value.
Once all the creditors are settled in liquidation, the preference shareholders will be paid off for their investment; following which the ordinary shareholders will be settled if there are any funds left. The capital contributed by ordinary shareholders is also called ‘risk capital’ due to the fact that they are settled last.
Reasons for Liquidation
- Lack of business vision and planning
Companies should always have clear strategic, financial and operational goals. Without these, it cannot successfully plan for the future
- Poor marketing
Companies have to invest in marketing and sales forecasts than ever before due to the high competition. If this is not properly done, then the company’s products and services will be soon forgotten by customers
- Obsolete technology
Technologically advanced selling, marketing and distribution methods are very popular among businesses. In order to successfully face the competition, the company must engage in technology.
- Inadequate financial skills
Sound financial knowledge and skills are required to conduct a business with a profit motive. If the variables that contribute to profit cannot be understood properly and managed, then the business continuity is at stake
- Over-or-under trading
Over-trading is when the company is pursuing aggressive growth to an extent where it cannot be facilitated by the resources and funds available. Inadequate control can cause terminal cash problems in fast moving businesses. More common nowadays is under-trading, where business adopts a strategy of merely cutting costs to deal with their financial, operational and strategic problems in order to obtain short-term profits
- Negligent or fraudulent personnel
If the personnel, especially the top management are negligent or try to fulfill personal agendas without working towards the best interest of the company and shareholders, this can lead to liquidation. Further, some key personnel may attempt to indicate that the business is doing well through manipulation of financial accounts without revealing that the business is on the verge of insolvency. Major financial crimes such as Enron took place due to this reason.
Figure 1: Sudden collapse of Enron’s share price caused liquidation of the company
What is the difference between Administration and Liquidation?
Administration vs Liquidation |
|
| Administration is a recovery tool that assists an insolvent business to survive. | Liquidation is used to terminate the business by discontinuing trading. |
| Continuity | |
| The company will continue to survive as a new firm | The business will be terminated. |
| Companies | |
| Apple and General Motors are two major companies that survived due to Administration. | Enron, Lehman Brothers and WorldCom are popular companies that liquidated resulting in a major financial loss. |
Summary – Administration vs Liquidation
Once the company realizes that it is in insolvency, Administration and Liquidation is the two options that it can consider. The difference between administration and liquidation decides if the company continue to exist or not. The possibility of administration may not be an option for some companies if the destruction is in much worse situation.
Reference:
1. “Business Valuation Methods for When You’re Ready to Sell.” Findlaw. N.p., n.d. Web. 21 Feb. 2017.
2. Brindley, Paul. “The ten reasons companies are forced into liquidation.” Licensed Insolvency Practitioners. N.p., 21 Sept. 2014. Web. 21 Feb. 2017.
3. “What is a prepack administration sale?” Pre-Pack Administration – How can it save my business? N.p., n.d. Web. 21 Feb. 2017.
4. Hayes, CFA Adam. “7 Bankrupt Companies That Came Back.” Investopedia. N.p., 11 May 2015. Web. 21 Feb. 2017.
Image Courtesy:
1. “Enron Stock Price August 2000 to January 2001” By User:Nehrams2020 (original), User:0xF8E8 (SVG) – Derived from Image:EnronStockPriceAug00Jan02.jpg (CC BY-SA 3.0) via Commons Wikimedia