Consolidation as a type of merger

Consolidation has two primary meanings in the world of business and finance.

Consolidation as a type of merger

One meaning of consolidation is when two companies join to create a new company. This is a special kind of merger. In an expected merger, one company buys another company. The bought company stops existing as its own company. However, in consolidation, both original companies stopped existing. They combine everything to make a brand-new company.

Here’s how it works. Let’s say Company A and Company B want to consolidate. They made a new company called Company C. Company A and Company B stopped existing. All of the things they own (called assets) and all of the money they owe (called liabilities) now belong to the new Company C. The owners of Company A and Company B usually get shares (pieces of ownership) in the latest Company C.

Consolidation can happen for different reasons. Sometimes, two companies realize they can be stronger together as one new company rather than staying separate. Sometimes, it’s a way for a struggling company to join a more substantial company to survive. The details of each consolidation are unique.

Consolidation in accounting

The other primary meaning of consolidation is about accounting. Accounting is how companies keep track of all their money – what comes in, what goes out, what they own, and what they owe.

Many big companies own smaller companies. The big company is called a parent company. The smaller companies it owns are called subsidiaries. Each subsidiary has its separate accounting. However, the parent company also needs to show the finances of the entire group – the parent company and all its subsidiaries together. These are called consolidated financial statements or consolidated accounts.

Here’s how it works. Parent Company owns 100% of Subsidiary A and 80% of Subsidiary B. To make consolidated financial statements, the parent company combines its financial statements with those of Subsidiary A and Subsidiary B. But remember, it only owns 80% of Subsidiary B. So, for Subsidiary B, only 80% of each number is included in Subsidiary B’s financial statements.

The 20% of Subsidiary B that Parent Company doesn’t own is the minority interest. In the consolidated financial statements, the minority interest is separated. It shows how much of the group’s assets and profits belong to the owners of that 20% of Subsidiary B, not to Parent Company.

Consolidated financial statements are important because they show the total financial health of a parent company and all its subsidiaries. They let investors and others see the big picture of the whole group, not just the separate pieces.

Why do companies consolidate?

Companies choose to consolidate for different reasons. Here are some of the most common ones:

To grow bigger and stronger

When two companies consolidate, they combine all their resources – their money, people, knowledge, technology, and more. This can make the new consolidated company stronger than either company was on its own.

Think about it like this. Company A is good at making a product. Company B is good at selling products. If they consolidate, the new company can be good at both making and selling the product. It can do more than either company could do alone.

To save money

Companies that consolidate can often save money. They might not need as many employees because jobs can be combined. They can share things like offices and equipment instead of each having their own. They can buy supplies in bigger amounts for lower prices.

Saving money lets the consolidated company make more profit. Or it can use the money it saves to grow in other ways, like making new products or going into new markets.

To get into new markets

When companies consolidate, they can get access to new markets. For example, Company A sells its products in the United States. Company B sells similar products in Europe. If they consolidate, the new company can sell in both the United States and Europe. It has a bigger market than either company had before.

To get rid of competition

Sometimes companies consolidate with a company that was a competitor. This can help in two ways. First, they don’t have to compete with that company anymore. Second, they get all the customers of that company. The consolidated company can have a bigger share of the market.

What are the risks of consolidation?

While consolidation can have benefits, it also has risks. Companies need to think carefully before they decide to consolidate. Here are some of the possible downsides:

Culture clash

Every company has its own way of doing things – its own culture. When two companies consolidate, there can be a culture clash. The employees of the two companies might have trouble working together. They might have different ideas about the best way to do things.

Cultural problems can make it hard for a consolidated company to run smoothly. The new company might not be as successful as hoped if the employees can’t work well together.

Debt and expenses

Consolidating companies have to pay lawyers, accountants, and other professionals to help with the process. This can be expensive. The consolidated company also takes on any debts the original companies had. If those debts are large, they can be a big problem for the new company.

Job losses

When companies consolidate, they often end up with more employees than they need. This can lead to layoffs, where some employees lose their jobs. This is hard for the employees who are let go. It can also be bad for morale among the employees who stay.

Less competition

When companies consolidate, especially those that are competitors, it means fewer companies are in that market. This can lead to less competition. Less competition can mean higher customer prices because the consolidated company doesn’t have to compete as hard for business.

How do consolidated financial statements work?

As mentioned before, consolidated financial statements combine a parent company’s and its subsidiaries’ financial statements. This shows the financial position of the whole group as if it were a single company. But there are some specific things about how consolidated financial statements work.

Eliminating intercompany transactions

Sometimes, a parent company and its subsidiaries do business with each other. For example, the parent company might sell supplies to a subsidiary. In the parent company’s financial statements, this looks like income. In the subsidiary’s financial statements, it looks like an expense.

However, in the consolidated financial statements, these transactions need to be eliminated. Why? Because from the view of the whole group, no money was gained or lost. The money just moved from one part of the group to another.

Minority interest

As mentioned earlier, minority interest is the part of a subsidiary the parent company doesn’t own. In the consolidated financial statements, the minority interest’s share of the subsidiary’s assets and profits is shown separately.

This is important because the consolidated financial statements should only show the assets and profits that belong to the parent company’s owners. The minority interest’s share belongs to other owners, not the parent company.

Goodwill

When a company buys another company, it might pay more than the fair value of the bought company’s assets. The extra amount is called goodwill. In consolidated financial statements, goodwill is an asset. It represents the value of the bought company’s reputation or customer relationships.

Goodwill is not always a straightforward thing to account for. It doesn’t directly generate cash like a piece of equipment or a factory does. Sometimes, goodwill has to be “written down” or reduced if the company bought isn’t as valuable as initially thought. This can make a group’s finances look worse.