Synergy is the most essential component of mergers.
In mergers, synergy between the participating firms determines the increase in value of the combined entity. In other words, it refers to the difference between the value of the combined firm and the value of the sum of the participants. Synergy accrues in the form of revenue enhancement and cost savings.
a) Operating synergy: This refers to the cost savings that come through economies of scale or increased sales and profits. It leads to the overall growth of the firm.
b) Financial synergy: This is the direct result of financial factors such as lower taxes, higher debt capacity or better use of idle cash. When a firm with accumulated losses or unabsorbed depreciation merges with a profitable firm and the combined firm can set off such losses against its profits, a financial synergy, known as tax shield, occurs.
