Corporate Finance: Mergers, Goodwill, SEBI Rules, Debt, and Cash Flow

Posted on Dec 15, 2024 in Economy

Amalgamation: Merger vs. Purchase

Here’s a clear distinction between amalgamation in the nature of merger and amalgamation in the nature of purchase:

Amalgamation in the Nature of Merger

1. Pooling of Interests: Two or more companies combine to form a new entity, pooling their assets, liabilities, and interests.
2. No Consideration: No payment is made by one company to the other; instead, shares are exchanged.
3. Common Control: The combined entity is controlled by the shareholders of the amalgamating companies.
4. Accounting Treatment: Assets and liabilities are combined at their carrying values, and no goodwill is recognized.
5. Example: Two companies, A and B, merge to form a new company, C. The shareholders of A and B become shareholders of C.

Amalgamation in the Nature of Purchase

1. One Company Acquires Another: One company (the acquirer) purchases the assets and liabilities of another company (the acquiree).
2. Consideration is Paid: The acquirer pays a purchase price to the acquiree’s shareholders.
3. No Common Control: The acquirer has control over the acquiree’s assets and liabilities.
4. Accounting Treatment: Assets and liabilities are recorded at their fair values, and goodwill is recognized.
5. Example: Company A purchases Company B’s assets and liabilities for a consideration of $100 million. Company A becomes the owner of Company B’s assets and liabilities.

In summary, amalgamation in the nature of merger involves pooling of interests, no consideration, and common control, whereas amalgamation in the nature of purchase involves one company acquiring another, consideration is paid, and no common control.

Factors Affecting Goodwill Valuation

Here are the factors affecting the valuation of goodwill:

• Earning Capacity: The company’s ability to generate profits and its past earnings record.
• Market Position: The company’s market share, competitive advantage, and reputation.
• Growth Prospects: The company’s potential for future growth and expansion.
• Quality of Management: The competence and experience of the company’s management team.
• Industry and Market Trends: The company’s position within its industry and the overall market trends.
• Intangible Assets: The presence of intangible assets such as patents, trademarks, and copyrights.
• Location and Premises: The location and quality of the company’s premises.
• Customer Base and Loyalty: The size and loyalty of the company’s customer base.
• Suppliers and Partnerships: The quality and reliability of the company’s suppliers and partnerships.
• Regulatory Environment: The regulatory environment in which the company operates.

These factors can either increase or decrease the value of goodwill, depending on their presence and significance.

SEBI Guidelines for Bonus Share Issue

Here are the SEBI guidelines in the context of the issue of bonus shares:

1. Authorization: The issue of bonus shares must be authorized by the Articles of Association of the company.
2. Board Resolution: The Board of Directors must pass a resolution to issue bonus shares.
3. Shareholders’ Approval: The issue of bonus shares must be approved by the shareholders in a general meeting, unless the Articles of Association provide otherwise.
4. Bonus Share Ratio: The bonus share ratio must be determined by the Board of Directors and approved by the shareholders.
5. Out of Reserves: Bonus shares can only be issued out of free reserves, securities premium account, or capital redemption reserve account.
6. No Cash Flow Impact: The issue of bonus shares should not have any impact on the cash flow of the company.
7. No Change in Shareholding Pattern: The issue of bonus shares should not result in any change in the shareholding pattern of the company.
8. Compliance with Listing Agreement: The company must comply with the listing agreement and other regulations of the stock exchange.
9. Disclosure Requirements: The company must make necessary disclosures to the stock exchange and the shareholders regarding the issue of bonus shares.
10. Accounting Treatment: The company must follow the accounting treatment prescribed by the Institute of Chartered Accountants of India (ICAI) for the issue of bonus shares.

Understanding Debt Capital

Debt capital refers to the funds raised by a company through borrowing from various sources, such as banks, financial institutions, debenture holders, and bondholders. It involves the issuance of debt securities, like debentures, bonds, and commercial paper.

Characteristics of Debt Capital

1. Fixed interest rate
2. Fixed repayment schedule
3. No ownership dilution
4. Tax-deductible interest

Advantages of Debt Capital

1. Lower cost of capital
2. No loss of control
3. Tax benefits

Disadvantages of Debt Capital

1. Fixed repayment obligations
2. Risk of default
3. Increased financial leverage

Pro-Forma Balance Sheet (Schedule III, Companies Act 2013)

Here is a pro-forma of a Balance Sheet based on Schedule III of the Companies Act 2013:

BALANCE SHEET

As at [Date]

I. EQUITY AND LIABILITIES

1. Shareholders’ Funds

• Share Capital
• Reserves and Surplus
• Money Received Against Share Warrants
• Share Application Money Pending Allotment

2. Share Application Money Pending Allotment

3. Non-Current Liabilities

• Long-term Borrowings
• Deferred Tax Liabilities (Net)
• Other Long-term Liabilities
• Long-term Provisions

4. Current Liabilities

• Short-term Borrowings
• Trade Payables
• Other Current Liabilities
• Short-term Provisions

II. ASSETS

1. Non-Current Assets

• Fixed Assets
  • Tangible Assets
  • Intangible Assets
  • Capital Work-in-Progress
• Non-Current Investments
• Deferred Tax Assets (Net)
• Other Non-Current Assets

2. Current Assets

• Current Investments
• Inventories
• Trade Receivables
• Cash and Cash Equivalents
• Short-term Loans and Advances
• Other Current Assets

III. CONTINGENT LIABILITIES

1. Claims Against the Company Not Acknowledged as Debts
2. Guarantees
3. Other Contingent Liabilities

IV. COMMITMENTS

1. Estimated Amount of Contracts Remaining to Be Executed on Capital Account
2. Uncalled Liability on Shares and Other Investments

Note: This is a general pro-forma, and the actual format may vary depending on the specific requirements of the company and the applicable accounting standards.

Calculating Net Cash Flow from Operating Activities

Here are the different methods of calculating net cash flow from operating activities, along with examples:

Direct Method

The direct method involves calculating the net cash flow from operating activities by adding up the cash inflows and subtracting the cash outflows.

Example:

Indirect Method

The indirect method involves calculating the net cash flow from operating activities by adjusting the net profit for non-cash items and changes in working capital.

Example:

Steps in Calculating Net Cash Flow (Indirect Method)

1. Start with the net profit.
2. Add back non-cash items such as depreciation, amortization, and impairment losses.
3. Adjust for changes in working capital, such as increases or decreases in accounts receivable, accounts payable, and inventory.
4. Calculate the net cash flow from operating activities.

Note: The direct method is more straightforward, but it requires detailed information about cash inflows and outflows. The indirect method is more commonly used, but it requires adjustments for non-cash items and changes in working capital.