Dell Working CapitalQ1: How was Dell’s working capital policy a competitive advantage?

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.• New technological up gradations can be easily set into the system before the

competition turns over the existing inventory. Thus Dell had a first mover’s 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 competitions average of $436mn for the same amount of COGS.

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

When we compare Dell’s 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.

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)Percentage

Increase1997 ($ mn)[projected]

Sales 5296 50% 7944COGS 4229 50% 6344Gross Margin 1067 1067OE 690 50% 1035Operating Income 377 565Other Income 6 0Taxes 111 170

Net Income 272 395

Year 1996 ($ mn) Days1997 ($ mn)[projected]

Cash 55 --- 55Short Term Investments 591 --- 591Accounts Receivables 726 44 1189Inventories 429 31.15 654Others 156 --- 156Current Assets: 1957 --- 2645Accounts Payable 466 37.45 835Other Liability 473 --- 473

Current Liabilities: 939 1308

Cash Conversion Cycle 37.7

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. 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.