B17005|Akshat Gupta

DELL’s Working Capital

FM1 Pre-Read Assignment - IV

Submitted by:
Akshat Gupta
B17005| Section - A

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Case Background

Dell computer Corporation was founded in 1984 by then nineteen year old Michael Dell.
The company was in the business of designing, manufacturing selling and servicing high
performance personal computers (PCs) compatible with industry standards. Initially they
purchased IBM compatible personal computers, upgraded them, and then sold the
upgraded PCs directly to businesses by mail order. Subsequently they began to market
and sell their own brand of personal computer, taking orders over toll free telephone line,
and shipping directly to customers.

Dell had lower daily supply of inventory compared to its competitors, especially since
1994 which provided it with a competitive edge.

In 1990, Dell was faced with a choice. It could either choose to remain the same size as it
was or expand. The consolidating market of PC forced Dell to expand. It broke from
direct-only business and began selling through indirect distribution channels. It also
pursued sales in foreign markets through resellers. The sales increased hugely by 268%
compared to 5% growth rate of the industry.

Although in 1993, the company reported its first loss of $76 Million in the second quarter.
The loss was tied to $71 million in charges relating to sell-off of excess inventory and the
cost of scrapping a disappointing notebook computer line. The company also took
restructuring charges to consolidate European operations that had become redundant and
inefficient.

Dell shifted its focus from exclusively growth to liquidity, profitability and growth. It
adopted company-wide metrics around the new focus, requiring each business unit to
provide detailed profit & loss statements. In 1995, Dell instituted goals on ROIC (Return
on Invested Capital) and CCC (Cash Conversion Cycle). The company took measures to
improve its internal systems for forecasting, reporting, and inventory control. A new
vendor certification was put in place, reducing the number of suppliers, ensuring
component cycle, and improving delivery performance.

It also entered into the notebook market to gain market share and introduced new Pentium
microprocessor chips in its systems.

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Financial Problems
5 problems identified:
 How does limited finished goods inventory affect the finance
of the company?
 How did Dell finance the 52% growth?
 Cash and cash equivalent that the company should keep
with itself?
 Changes to be made to working policy?
 How to finance future growth?

1. How does limited finished goods inventory affect the finance of the
company?

Dell works on a make-to-order model which enables the company to customise the
product for the customers and deliver the same within a few days. This is a big
differentiating factor for Dell against its competitors.

Although Dell did not maintain much inventory of finished goods, it maintained
an inventory of the components required to build the system. Technology sector,
being dynamic sees a lot of upgrade and changes. Maintaining an inventory of
components was a bit disadvantageous for the same reason as price of the
components fell when a new technology came in the market.

Dell should consider if keeping a higher inventory of finished products might be

beneficial.

2. How did Dell finance the 52% growth?

Dell shifted its focus from exclusively growth to liquidity, profitability and
growth. The loss was tied to $71 million in charges relating to sell-off of excess
inventory and the cost of scrapping a disappointing notebook computer line. The

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company also took restructuring charges to consolidate European operations that

had become redundant and inefficient.

It adopted company-wide metrics around the new focus, requiring each business
unit to provide detailed profit & loss statements. In 1995, Dell instituted goals on
ROIC (Return on Invested Capital) and CCC (Cash Conversion Cycle). The
company took measures to improve its internal systems for forecasting, reporting,
and inventory control. A new vendor certification was put in place, reducing the
number of suppliers, ensuring component cycle, and improving delivery
performance.

The change in goals was followed by a 52% growth in sales in 1996.

3. Cash and cash equivalent that the company should keep with itself?
With $32 Million in cash and cash equivalents, analysts thought that Dell had
enough cash and credit to last at least another year, but many wondered if the
company had the resources to keep pace should the battle for market share
intensify.

The company should maintain an optimal amount of cash and cash equivalents and
probably invest the rest into some other profitable ventures and not keep the cash
idle.

4. Changes to be made to working capital policy?

The company needs to look at its inventory policy since it faced losses due to the
price fluctuations of the components.

The company also needs to decide on the cash component to keep with itself. They
should use the excess cash and invest in some other profitable ventures.

5. How to finance future growth?

Dell can consider external source of financing such as debt or equity to fund
growth related activities. They should do a cost benefit analysis and optimise their
cost of capital by considering cost of debt and equity.
The company also needs to decide on the cash component to keep with itself. They
should use the excess cash and invest in some other profitable or growth related
ventures.

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Analysis and Interpretations

Dell’s Working Capital Policy

Advantages:

 Low finished goods, low carrying cost, reinforces build-to-order strategy

 Quicker time to market in case of defective products
 When component cost reduces, easier to pass on to the customers
 Low Cash Conversion Cycle
 More sales on credit basis
 Higher return on capital employes

Disadvantages

 Led to component shortages in 1996

 Larger dependence on high quality supplies from manufacturers
 When product changes, they need to start the process afresh replacing the old
process

Low Inventory Holding

Carrying cost solely depends on the Days supply of Inventory (DSI).

Cost of Sales during 1995 : $2737 Mn

Cost of sales per day : 2737/365 = $7.5 Mn

DSI dell = 32

DSI Compaq = 73

Inventory holding of Compaq over Dell = (73-32)*7.5 = $307.5 Mn

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Compaq has to sell off its old inventory before purchasing new goods.
There is a loss of benefits from purchase of low cost, new technology inventory.
Compaq’s opportunity cost = 0.3*307.5 = $92.25 Mn

52% Growth

Dell shifted its focus from exclusively growth to liquidity, profitability and growth. The
loss was tied to $71 million in charges relating to sell-off of excess inventory and the cost
of scrapping a disappointing notebook computer line. The company also took
restructuring charges to consolidate European operations that had become redundant and
inefficient.

It adopted company-wide metrics around the new focus, requiring each business unit to
provide detailed profit & loss statements. In 1995, Dell instituted goals on ROIC (Return
on Invested Capital) and CCC (Cash Conversion Cycle). The company took measures to
improve its internal systems for forecasting, reporting, and inventory control. A new
vendor certification was put in place, reducing the number of suppliers, ensuring
component cycle, and improving delivery performance.

Total Asset (excl short term investments) in 1995 should grow = 1594 – 484 = $1110 Mn

Ratio of sales should remain intact

Required increase to maintain growth = 0.3194*0.522*3475 = $579.37 Mn

It should be met without support of increase in account payables.

Cash flow from increase in cumulative liabilities = (2148-466) – (1594-403)

= $491 Mn

Net Profit Margin = 149/3475

= 4.29%

Cash Flow from Net Profit = 0.0429*1.522*3475

= $226.89 Mn

Cash Inflow is more than Cash outflow in 1996, which means that Dell has got enough
money to fund its growth in 1996 internally

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Can Dell fund in 1997?

Michael Dell predicted that company’s growth rate would be higher than industry’s
growth rate in 1997.

To check whether this can be achieved with internal sources of funds, we do a forecast
based on the model we used for 1996

Operating assets in 1996= Total assets- short term investment= 2148-591= $1557 million

Operating assets to sales ratio in 1996= (1557/5296)*100= 29.4%

Forecast sales in 1997= 5296+ 50%*5296= $7944 million

Operating assets in 1997, keeping operating assets to sales ratio constant= 29.4%*7944
= $2336 million

Operating assets in 1996= $1557 million

Working capital gap= $(2336-1557=779) million

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Recommendations

 As per the analysis, the funds for future growth can continue to come from internal
sources of financing. The company generates sufficient profits and operating asset
contribution so as to maintain the required growth rate of the company.

 Dell has a focus on liquidity because of which it needs to maintain an optimal

amount of cash with itself. The above analysis shows that it has sufficient cash and
cash equivalents

 Dell computer corporation, though a late entrant in personal computer

manufacturing market had established its niche image through innovative build-to-
market manufacturing processing. This new strategy helped grow Dell
exponentially in just first 15 years of inception of Dell and helped it reach one of
the top five companies in this industry. Dell in period of 1990-1992 grew by 268%
compared to market growth of 5%. They should continue with it.

 Dell needs to keep an optimal amount of finished goods inventory. To prevent the
kind of losses that happened due to component shortages, they need to compensate
by keeping higher finished goods inventory.

 Dell’s cash conversion cycle has been consistently lower than its competitor.
Thus, Dell continue with its strategy to keep its competitive advantage intact. At
present its cash balances and working capital are sufficient to sustain its growth in
1997 at 52% rate as the previous year.