Financial Management for Business Combinations

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Table of Contents

Why do firms purchase other corporations?
Do firms pay too much for the acquired corporation?
Why do so many acquisitions result in shareholder losses?
References

Why do firms purchase other corporations?

Firms acquire, merge, and purchase other companies for various reasons; the main reason is to have improved sales revenue and business gains. The following are the main reasons why firms decide to buy others in the same line:

To improve their sales concentration by reducing competition.
To enjoy economies of scale that is likely to result from an increased business after the purchase.
To enjoy operational benefits that might be with the sold company.
To consolidate the market and enjoy management efficiencies that might come with the new acquisition.

When a purchase is made, both companies conduct the exercise with mutual benefits to have a better company than when they are operating independently (Zeff & Goldberg, 1964).

Do firms pay too much for the acquired corporation?

When determining the cost of the company to be purchased, the management of the two companies have to value the assets, the potentials, and the perceived benefits or losses that the company is having; there is also a consideration of the debtors and creditors of the acquired company as well as contingency accounts.

The final cost determination should follow International Financial Reporting Standards and International Standards of Accounting, both parties should accept it and the concerns of either looked into. Sometimes depending on the nature of the contract and following international accepted manner, the company can decide to buy the company at a discount that can be seen as a higher value of the company; this should not cause an alarm since when it happens; a perceived future benefit that has been purchased.

When the accepted mode of purchase is used, there is no risk of busing the business at a higher price than the company is worth, the much that can be the difference is goodwill or the discount on purchase, which can be seen as intangible assets, acquired (Rodkey, Glover, Janes, Grether, Tolman & McCabe, 2009)

Why do so many acquisitions result in shareholder losses?

Depending on the contact that a company engages in, there are chances that some shareholders will lose their ownership of the business, the method of purchase is called acquisition.

According to this method, the buying company acquires or purchases shares in another company or company and pay cash or issue its own shares or loan stock in exchange for those shares; this may result in loss of shareholding of the old shareholders.

If much of the purchase price is paid in cash, then there is a significant outflow of cash from the group. This adjustment has to be done when accounting for a combination. This method is based on the principle that the holding company acquires control over all assets of the other company even though it does not necessarily have to take over a 100% of the hares of the other company. The main feature of consideration in this method is the determination and accounting for pre-acquisition profits of the subsidiaries are regarded as capital from the group point of view and therefore do not appear anywhere in the consolidated group reserves (Reed, Lajoux & Nesvold, 2007).

An acquisition is guided by International financial reporting standards (IFRS) 3, which offer guidelines on how the process should be conducted and how to value the acquired business. The same standard offers a guideline for reporting of business combinations (acquisitions and mergers).

References

Reed, S. F., Lajoux, A. R. & Nesvold, P. H. (2007). The art of M & A: a merger, acquisition, buyout guide. New York: McGraw-Hill Professional.

Rodkey, R., Glover, C., Janes, G., Grether, E., Tolman, C., & McCabe, G. (2009). Accounting, Business Methods, Investments, and Exchanges. American Economic Review, 19(2), 289-300.

Zeff, S., & Goldberg, L. (1964). A Critical Study of Accounting for Business Combinations (Book). Accounting Review, 39(1), 230.

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Financial Management for Business Combinations

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