Expansion is a crucial part of any business or company’s operations. Every entity works to grow and expand its operations. Whether these are small or large organizations, growth and expansion are among the factors that measure success. Usually, the primary objective behind this process involves attracting more customers or serving more people.
Regardless of the type of product a company sells or its brand, financial figures can be highly critical. When companies grow, understanding their finances becomes more crucial. This understanding allows them to understand their operations better and respond to any challenges. One term often associated with this process is accretion, the adjective form of which is accretive.
The term accretive has a meaning in every field. While it usually has a similar meaning, the context for this term changes how entities perceive it. Accretive is also an expression often used in finance. However, in corporate finance, accretive can have several meanings. Before understanding the different contexts for the term accretive, it is crucial to know its meaning.
What does Accretive mean in finance?
In finance, the term accretive refers to a positive change in value after a transaction occurs. However, this change may apply in various contexts. For example, it can refer to the positive change in the value of an acquisition after it occurs. Similarly, it can apply to the value of bonds after investors buy them at a discount to their par value. The noun form of accretive is accretion, which shows an accretive change.
In general, the term accretive means gradual or incremental growth. This meaning also translates into the world of finance, where it refers to an increase in value. Often, accretive also has another word attached to it which enhances its meaning. For example, accretive acquisition refers to the growth in a company’s value after completing an acquisition.
The concept of accretion can also apply to bonds, where its value increases after buying it at a discount. However, its materialization depends on the completion of the transaction. If the value of a capital asset increases without a financial transaction, it does not fall under accretion. Generally, an accretive change involves buying an asset at a lower value, expected to increase later.
The term accretive in finance can apply to several scenarios. Most commonly, it gets associated with acquisitions. However, it may also relate to the increase in the value of bonds. Accretion also has a meaning in accounting. There, it has a similar context as in finance. Accountants usually account for an accretive change by recording the incremental value in the financial statements.
Overall, the term accretive means a positive change or increase in worth. In finance, it refers to the growth or increment in a capital asset’s value upon the successful competition of a financial transaction. There are several contexts in which this term may apply in accounting. For example, accretive acquisitions and accretive bonds are common usages for it.
What does Accretive Acquisition mean?
The term acquisition means purchasing something. In finance, however, it has more meaning. An acquisition is when one company acquires another company’s share and obtains control over it. Usually, this involves buying more than 50% of the acquired company’s stock. In most circumstances, companies pay for these transactions through bank or cash. However, it may also involve other considerations.
An accretive acquisition is when a company purchases another company and gets earnings per share boost. Usually, when one company acquires another, it signals dominance in the market. This process ensures the shareholders that the acquirer has enough assets to expand its operations. Therefore, an accretive acquisition has a favorable impact on the company’s share prices.
For accretive acquisitions, the acquiring company must pay a lower price than the boost it gets. Usually, companies receive an increment in their EPS in most acquisition deals. However, if the price paid is lower than the boost they get, it becomes accretive. In general, if the acquiring company’s price-earnings ratio is higher than the target company, an accretive acquisition will occur.
Usually, accretive acquisitions involve the acquiring company purchasing a company with a low price-earnings ratio. Through this process, it gets an EPS boost, which further enhances its market value. This process may also come close to the definition of bootstrapping in finance. However, accretive acquisitions occur in a positive way rather than exploitative.
Overall, accretive acquisitions increased the synergy between the two companies, the acquirer and acquired. Through this transaction, the combined value of both companies becomes higher than their separate identities. This process can provide a significant boost to the company and its operations. An accretive acquisition increases the total value of the combined entity after the purchase process.
What does Bond Accretion mean?
In finance, the term accretive may also apply to bonds. Usually, an issuer issues bonds for the par value. A buyer acquires the bond and holds it until maturity or before that. Accretion, when it comes to bonds, is the opposite of amortization. Amortization occurs when an issuer pays the value of debt through scheduled, pre-determined payments. Usually, these payments include both principal and interest amounts.
Instead, accretion in bonds involves buying a bond at a value lower than par. Some issuers may issue their bonds at a lower price to attract more finance. In other circumstances, the value of bonds may fall in the market due to several reasons. Either way, accretion occurs when the price paid for acquiring a bond is lower than its par. The difference, in this case, becomes the accretion within the transaction.
This concept also applies in accounting. When a company issues a bond, it may expect to repay it within the new few years. However, accounting standards require the company to record a liability for the present value of the bond. In the future, this liability may increase due to several reasons. Therefore, the incremental value recorded due to an increase in the bond’s present value becomes the accretion.
In accounting, an accretion expense is a difference between the present value of a bond. However, this value must increase, resulting in a higher liability for it to be an expense. This concept doesn’t apply to bonds only but to all financial instruments where the obligation may increase. In most circumstances, the value of bonds increases as they get closer to maturity. Therefore, bond accretion occurs after every evaluation date.
How does Accretion apply to companies?
For most smaller companies and startups, the term accretive or accretion won’t apply. Usually, these companies are small in size and don’t encounter bond accretion or accretive acquisitions. However, for larger companies, this term may be crucial. These include established companies and public companies. These companies use bonds and may indulge in acquisitions.
Most public companies invest in others. These may include obtaining subsidiaries or forming associates with some control. However, some may also acquire other companies. These acquired companies usually include smaller companies or startups. In these cases, the acquirer company may encounter accretive acquisition due to a value increase through the transaction.
These companies also use bonds to raise finance. As mentioned above, as these bonds come close to maturity, they will increase the underlying company’s lability. Therefore, the company will record an accretion expense, which relates to the incremental present value. In this case, accretion will also apply to these companies.
Conclusion
The term accretion means the increase in value, which has an adjective form of accretive. Accretive, in finance, can have several meanings. Generally, it refers to the growth in value of a capital asset due resulting from a transaction. There are two prevalent scenarios in which this concept may apply. These include accretive acquisitions and bond accretion.
