Business owners may not feel that a grounding in finance is crucial for success. And they’re not necessarily wrong. Nonetheless, no matter how stellar your branding, how amazing your product, or how superlative your customer service, the health of your business’ finances can make or break you. And as your business grows, your understanding of finance will need to grow with it, if you’re to respond effectively to the changing challenges your company faces.
Accretion comes across as jargon known only to brokers, day traders and seasoned investors. But it may be useful to understand this term for the benefit of your business and its shareholders. So, what is accretion? How do we define whether something is accretive? And how will this understanding benefit your operation?
Let’s take a closer look…
What is accretion?
First, it doesn’t mean someone from Crete. Accretion has several meanings, depending on the context in which it’s used, and the term is most commonly found in the worlds of accounting and finance. Broadly speaking, however, it refers to the determination of a bond’s future value.
In real terms it refers to:
The amount of money added to a bond’s liability balance each quarter (or relevant reporting period).
The additional earnings that a company receives after acquiring or merging with another company.
An acquisition is considered accretive if the combined earnings per share (EPS) exceed the acquirer’s EPS before the merger or acquisition. The opposite of accretion is dilution. If the EPS actually decreases in the wake of an acquisition, it is referred to as dilutive.
What does accretion mean in finance?
A bond’s accretion is the growth in its value over time, and as it gets ever closer to its maturity date. Bond accretion is accounted for using two distinct methods:
The straight line method: Here the increase in a bond’s value is spread evenly throughout its term. A 3-year bond, in this case, will have 12 periods until it reaches maturity.
The constant yield method: Here, the bond’s value increases more and more the closer it gets to its maturity date, with the gains back-loaded towards the end of its life cycle.
So far, so good. But...
How does accretion relate to your business?
If you’re a small business or microbusiness, it probably doesn’t… yet. But if you reach a size where you become a public limited company and become beholden to shareholders, it could mean a great deal. Especially if you reach a point where you’re ready to acquire other companies.
Accretion or dilution can have a lasting impact on the value of your shares in the event of a merger or acquisition.
Let’s say you reach a size where you’re ready to acquire another company in order to increase your EPS. You reported $250,000 net income last year, and on top of this you have 1,000,000 shares outstanding. The company you want to acquire, on the other hand, reported $120,000 and sold 200,000 new shares to raise enough money to purchase the outstanding shares.
We now have all the information we need to calculate the EPS of both companies and determine whether or not the acquisition would be accretive:
Your EPS= 250,000 / 1,000,000= $0.25.
The combined company’s EPS= 370,000 / 1,200,000= $0.31
As we can see, this acquisition would be accretive by 6 pence per share.
Furthermore, if you are an investor outside of your business interests, a sound understanding of accretion can ensure that you better understand the implications of mergers and acquisitions for your investments.
We can help
If you’re interested in finding out more about accretion, or anything to do with your business finances, then get in touch with the financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.