Dell’s Working Capital Policy Analysis

GROUP 8
 DELL COMPUTER CORP.

Founded in 1984 Designing, Direct selling strategy Their ‘build to order Outpacing industry
manufacturing, selling model’ resulting in growth rate
and servicing high lower inventory amount
performance PC
PROBLEM BACKGROUND

Supporting growth rate Inventory shortage due to

(50-52%) greater than strict ‘build to order’
sustainable rate (32%) model
THE THREE OPTIONS
Option ONE
01 Maintaining current working capital policy

Option TWO
02 Financing future growth internally

Option THREE
03 Financing future growth externally through equity issue and
borrowing

Option FOUR
04 Financing future growth through a combination of both sources
ANALYSIS
How was Dell’s working
#1 capital policy a competitive
advantage?
 Capital conservation due to
lower inventory holding policy

Inventory savings at Inventory savings at industry

Compaq’s DSI level average method:
calculation:
Average inventory savings = Average inventory savings = (52-
(Compaq’s DSI – Dell’s DSI) 32) *($2737/365) = $149.97 million
* (Dell’s COGS/365)

= (73-32) * ($2737/365) =
$307.44 million
 Reduction of obsolescence
risk and inventory cost

As a % of Cost of DELL COMPAQ

Sales
Inventory 8.7 1
20
Inventory Loss 2.61 2
7

*1 : Dell’s inventory = Dell’s DSI*(Dell’s COGS/365) = 32*(2737/365) = $239.96 mn

*2 Volatility of components price = 30%

 Efficiency in term of DSI

Days Supply of Inventory (DSI)

YoY YoY Efficiency in Day Terms

1993 Efficiency 1994 Efficiency 1995 1993 -1995
Dell Computer 55 67% 33 3% 32 23 Days
Apple
Computer 52 -39% 85 57% 54 -2 Days
Compaq
Computer 72 20% 60 -18% 73 -1 Days
IBM 64 12% 57 19% 48 16 Day
Dell’s Build-to-Order model
ANALYSIS
How did Dell fund its 52%
#2 growth in 1996?
 TOTAL FUND REQUIRED

Fiscal Year 1996(E) 1995

Fixed asset investment $974.32 mn $641 mn
Working capital investment $188.48 mn $124 mn
Total $1162.8 mn $765 mn

*Assuming similar fixed asset to sales and working capital sales ratio in 1995 and 1996
 TOTAL SOURCES OF FUND

Funds flow statement 1996

Items 1996 (E)(in mn)
Net profit $226.48
Less: Dividend 0
Operating cash flow $226.48
Internal funds $226.48
   
Borrowing $58.76
Equity issue* $112.56
External funds $171.32
Total sources of funds $397.8 mn

*Equity issue = 1996’s equity – 1995’s equity – 1996’s retained earnings

 Performance Evaluation

Indicators 1995 1996(Actual)

Assets Turnover
2.18 2.46
Ratio

Current Liabilities As
21.6 17.7
% of Sales
ANALYSIS
Assuming Dell sales will grow 50% in
1997, how might the company fund its
#3 growth internally? How much would
working capital need to be reduced/ or
profit margin increased? What steps
do you recommend?
 ASSUMPTIONS
1 Sales growth, g = 50%
2 Income statement items will be increased proportionately with increased
sales.
3 Net working capital ratio will be same as 1996 (16.9% of sales)

4 Other liabilities are considered as a part of working capital.

Fixed assets investment ratio will be 3.61% of total sales.
5
Debt ratio will be 10.41% of total assets
6
No cash dividends will be declared in 1997.
7
Working capital investment Internal fund $408 million
$447.5 million

External fund $143 million (Loan

Fixed asset investment $56.5 million + Share issue $78.5
$95.5 million million)

Total funds required Sources of funds

$543 million

External fund required must be fulfilled with OCF!

 1% Increasing net profit margin
from 5.14% to 6.14%

MANAGI
NG
INTERN
AL
SOURCE
Decreasing working capital S
ratio
from 16.9% to 15.7%
1.2
%
Total additional fund generation $174.77
million
Not relying on one option

Not changing the ratios by

significant amount

Increasing payment
deferral period

Selling off short term

investments

Recommendations for maintaining 50% growth internally

QUESTION
How would you answer to question no
3 if dell also repurchases $500 million
#4 of common stock in 1997 and repaid
its long-term debt?
 Operating Asset 778.50 Fiscal Year 1997 Cash Requirement 1,391.50
Short Term
Share Repurchase 500 591
Sales (50% Growth) 7,944.0 Investments
Long Term Debt Net Profit Margin (5.14%, 1996 Net Profit (Margin, 7%) 556.08
Repayment 113 Rate) 408.00 $244.42
Additional Fund
$1,391.50 6% Net Profit Margin $476.64 Requirement Million
Cash Requirement Million 7% Net Profit Margin $556.08
   

To generate funds for that So, if Dell wanted to implement this

Dell would maintain 50% growth,
repurchase $500 million
common stock and repay $113
Long Term Debt in 1997.
amount of cash requirement,
Dell may increase its profit
margin from 5.14% to 6% or
higher 7%.
strategy of repurchasing $500 million
common stock, repay $113 Long Term
Debt and at the same time continue to
grow at 50% rate, they need additional
$244.42 million funding in 1997.
 Overall Recommendations

EOQ Model Increasing days payables

outstanding
THANK YOU