Asset Base and Capital Structure

Asset Base

Analysis of the asset base requires an examination of changes in the composition of balance sheet assets over time. Presenting balance sheet items in a common size format (i.e., as a proportion of total assets) is a useful starting point.

We begin by examining a common size presentation of Thunderbird’s assets in Figure 12.5.

Figure 12.5: Total Assets

A manufacturing firm, such as Thunderbird, is expected to have considerable investments in both current assets (primarily receivables and inventory) and fixed assets (primarily plant, property, and equipment). However, note the significance of goodwill, which is 29.1% of total assets at the end of 2023.

Goodwill is an unidentifiable intangible asset representing the difference between the purchase price and market value of identifiable assets with finite lives in a business acquisition reported under the purchase method.

According to Figure 12.5, goodwill has increased since 2021, indicating Thunderbird has completed a number of business acquisitions.

The increases in Thunderbird’s EBIT margin and ROE (Figure 12.3) may be partially due to successful acquisitions. However, since goodwill is no longer amortized through the income statement, we must consider the possibility of losses in the future if goodwill is determined to have been impaired.

Capital Structure

A firm’s capital structure must be able to support management’s strategic objectives as well as to allow the firm to honor its future obligations.

Referring to Figure 12.3, Thunderbird’s financial leverage ratio has decreased over the last three years from 2.2 in 2021 to 2.0 in 2023.

Unfortunately, the ratio does not reveal the true nature of the leverage, as some liabilities are more burdensome than others. Financial liabilities and bond liabilities, for example, can be placed in default if not paid on time, or in the event of noncompliance with the lending covenants (i.e., technical default). On the other hand, liabilities such as employee benefit obligations, deferred taxes, and restructuring provisions are less burdensome and may or may not require a cash outflow in the future.

Next, we will examine the components of Thunderbird’s long term capital.

Figure 12.6: Long Term Capital

Thunderbird’s long term debt has decreased from 12.4% of long term capital in 2021 to 8.6% in 2023, a significant decrease in financial leverage.

Given that Thunderbird’s long term debt has decreased, we consider the possibility of an offsetting change in the firm’s working capital. Various working capital ratios are presented in Figure 12.7.

Figure 12.7: Selected Working Capital Data and Ratios

Both the current ratio and quick ratio have declined as a result of both the increase in notes payable and the decrease in marketable securities. The defensive interval ratio has been declining due to both an increase in daily expenditures and a decrease in marketable securities.

On the other hand, the firm appears to be better managing its receivables, inventory, and payables, as shown by a decrease in the cash conversion cycle from 31.0 days to 15.5 days. Receivables are being collected sooner (declining DSO), inventory turnover has increased (declining DOH), and the firm is paying suppliers more slowly (increasing days’ payables).