Dell Working Capital

Case Analysis

Submitted to: Professor Kulbir Singh Date: March 26, 2012

DELL WORKING CAPITAL

Q1: How was Dells working capital policy a competitive advantage?

Dell used its working capital policy as a competitive advantage by reducing the amount of WIP and finished goods inventory in its system. As a result of maintaining a minimum amount of inventory, Dell reduced its need for inventory financing, warehousing and inventory control. Dell kept its accounts payable (A/P) account to a minimum volume by waiting until the customers order was received before placing the release order with their suppliers. Dells suppliers were all located very close to Dells manufacturing plants, and made daily deliveries to Dell based on just-in-time delivery. By not receiving the parts until the last minute, Dell kept both its inventory and its accounts payable to a minimum. On the sales side, Dell took orders directly from consumers who normally pay with a credit card online, or over the phone. Because Dell waited until they received the order from the customer to start building the computer, Dell kept the CCC (cash conversion cycle to a minimum). If Dell were to operate at Compaqs DSI level, we estimate that Dell would have to increase its 1995 inventory from $293m to $668m, which is an increase of $375 million. This would mean that Dell would have needed to invest in $668 million in inventory. We believe that the main reason that Dell was able to maintain such a low level of inventory compared to their competition has a direct result of their competitive strategy to maintain a minimum level of inventory. Dell had a policy of working with low inventory and it used to make inventory purchases based on the sale orders received. This led to following advantages: No obsolete goods. Defects in raw material manufacturers were easily weeded out.

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New technological up gradations can be easily set into the system before the competition turns over the existing inventory. Thus Dell had a first movers advantage in being abreast with latest technological inclusion. High inventory turnover and low inventory days. This resulted in low cash conversion cycle.

From Table A, Dell had Days Supply of Inventory (DSI) as 32 days while the competition average for is: DSI average = (54 + 73 + 48) / 3 = 58 days Days inventory for the year is given by: DSI = 365 * Average Inventory / COGS From Exhibit 4, the COGS for Dell for 1995 is $2737 and the DSI is 32 days. Hence the Average inventory comes out to $239mn, which is almost $200mn less than the competition average of $436mn for the same amount of COGS. Table: Comparison of Dells Inventory Turnover to that of its competitors

Inventory Turnover Dell Compaq Gateway

1997 39.7 12.6 19.8

Inventory Turnover Dell Compaq Gateway

1998 44.4 9.6 34.6

Inventory Turnover Dell 3| Page

1999 60.1

Compaq Gateway Q2: How did Dell fund its 52% growth in 1996?

14.9 34.7

When we compare Dells performance in 1996 as compared to 1995, the Sale grew from $3475 to $5296 reporting a growth of 52.4%. However, the total assets in 1995 were $1594 i.e. 46% of sales and operating assets were total asset less short-term investment i.e. $1110 which is about 32% of sales. Thus when the sales grow by 52%, the operating assets need to grow in a similar proportion. Thus, the operating assets in 1996 must be Operating Asset
year 1996

= $5296mn * 32% = $1694mn

Thus the operating asset must increase by $584mn to meet the expenses, which will the additional funds that Dell must have procured. If we look at the sources of funds, the liabilities less accounts payable have increased by $500mn and the projected operational profit at 4.3% of projected increase in sale gives additional $230mn. Thus the firm can make sufficient funding through internal sources. The increase in current liability was $939-$752 = $187mn. The increase in current asset was $1957-$1470 = $487mn.

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Q3: Assuming Dell sales will grow 50% in 1997, how might the company fund its growth internally? How much would the working capital need to be reduced and / or profit margin increased? What steps do you recommend the company take? The Days Accounts Receivable comes out to 44 days. The Days Accounts Payable is 37.45 days while the Days Inventory Turnover is about 31.15 days. This brings the cash conversion cycle to 37.7 days. The 50% hike in revenue gives the projections as below:

Year

1996 ($ mn) 5296 4229 1067 690 377 6 111 272

Percentage Increase

1997 ($ mn) [projected] 7944 6344 1067 1035 565 0 170 395

Sales COGS Gross Margin OE Operating Income Other Income Taxes Net Income

50% 50% 50%

Year Cash Short Term Investments Accounts Receivables Inventories Others Current Assets: Accounts Payable Other Liability Current Liabilities: Cash Conversion Cycle

1996 ($ mn) 55 591 726 429 156 1957 466 473 939

Days ----44 31.15 ----37.45 --37.7

1997 ($ mn) [projected] 55 591 1189 654 156 2645 835 473 1308

Hence additional operating asset of $794mn is required to sustain the growth. The increase in the current liability acts as source of funds, which is $469mn. 5| Page

Estimated increase in net profits is about $123mn to reach the figure of $395mn. The short-term investment is assumed to stay the same as year 1996 i.e. $591mn. Hence we can safely say that the growth will be internally funded. Q4: How would you answer to Q3 change if Dell also repurchased $500 million of common stock in 1997 and repaid its long-term debt?

Incase of repurchase of stocks and repayment of debt, the investment requirement would shoot up by $500mn to become $1091mn. The already available funds are: Short-term investment of $591mn. The profit margin can be increased by 2% to yield an additional $159mn in funds. The shortfall left is of $432mn. These funds can be obtained by modifying the cash conversion cycle.

Inventory Days reduced by 15 days gives Inventory days at 16 (= 31 - 15) days. The savings can be calculated as: 10 * 6344 (COGS) / 365 = $173mn Accounts Receivable Days reduced by 4 days gives A/R days at 40 (= 44 - 4) days. The savings can be calculated as: 4 * 7944 (Sales) / 365 = $87mn Accounts Payable Days increased by 10 days gives A/R days at 47 (= 37 + 10) days. The savings can be calculated as: 10 * 6344 (COGS) / 365 = $173mn

This results in net addition of $433mn that will be sufficient to fund the working capital.

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