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Dells Working Capital

B.B.Chakrabarti
Professor of Finance
IIM Calcutta
The Questions

How was Dells working capital policy a


competitive advantage?

How did Dell fund its 52% growth in


1996?
The Questions
Assuming Dell sales will grow 50% in 1997, how
might the company fund this growth internally?
How much would working capital need to be
reduced and / or profit margin increased? What
steps do you recommend the company take?

How would your answer to the above question


change if Dell also repurchased $500 million of
common stock in 1997 and repaid the long-term
debt?
Dells Competitive Advantage
1) Conservation of capital due to lower inventory
holding
Compaq Dell
DSI in 95 73 32

Cost of sales of Dell in 95 = $2737 mn. (Ex.4)

Additional inventory at Compaqs DSI =


$2737 * (73-32) / 360 = $312 million
Dells Competitive Advantage
2) Reduced obsolescence risk and lower inventory
cost
Component cost can reduce by 30% a year as
new technology is introduced.
Inventory as % of COS Dell (8.9%) and
Compaq (20.3%)
Inventory loss due to 30% reduction in price
Dell (2.7%) and Compaq (6.1% of COS)
Comparative increase in profit in Dell in 96 =
$2.7 billion *(6.1%-2.7%) = $93 million
Dells Competitive Advantage
3) Quicker adoption of new technology
Dells low inventory levels resulted in
fewer obsolete components as
technology changed.
While Compaq had to market both new
and older systems due to high levels of
inventory, Dell could offer new and
faster systems quickly due to low
inventory and build-to-order models.
Funding 52% Growth in 1996
Facts to consider
95- Total assets = 46% of sales
95- ST investments = 14% of sales
95- Operating assets = 32% of sales
95- Net profit = 4.3% of sales
96- Dell would require 32% of increased
sales in operating assets i.e.
$(5296-3475)*32% = $582 million.
Funding 52% Growth in 1996
Facts to consider
96- All assets excepting ST investments
will grow at 52% over 95 figures
96- Assumed that the liabilities will also
proportionally increase.
96- Need additional $582 million assets
Funding 52% Growth in 1996
Facts to consider
96- Sources of funds:
- Increase in liabilities = $494 million
- Operational profit = $5296*4.3%
= $ 227 million
- ST investments = $484 million

Enough available money for internal funding


How Dell Funded 1996 Growth?
Facts
Higher asset efficiency
- Reduced cash, receivables, inventory
and other current assets
- Needed addl. $447 million of operating
assets
How Dell Funded 1996 Growth?
Facts
Sources of funds
- Increase in current liabilities = $187
million
- Net Profit = $272 million
How Dell Performed in 1996?
Dell introduced Pentium technology.
Unit sales grew by 48%.
Average unit revenue grew by 3%.
Gross margin declined by 1% due to
aggressive pricing strategies and account
mix shift.
Net margin improved from 4.3% to 5.1%
Common stock was issued to employees.
Funding 50% Growth in 1997
Facts to consider
96- Operating assets = 30% of sales
96- Net profit = 5.1% of sales
97- Dell would require 30% of increased
sales in operating assets i.e.
$(2336-1557) = $779 million.
Funding 50% Growth in 1997
Facts to consider
97- Increase in liabilities = $588 million
97- Net profit = 5.1% of $5296*1.5
= $405 million
ST investments = $591 million av.

So, internally growth can be funded.


97 with Repayment of LT Debt and
Repurchase of $500 mn. Of Equity
Funds needed = $984 million
Sources of Funds:
- 1% increase in margin = $79 million
- ST investments = $591 million av.
- Also, negative cash conversion cycle can do
( 97- Avg. daily sales = 96 sales*1.5/360
= $22.1 mn. and Avg. daily COS =
79.8% of sales as in 96 = $17.6 mn.
i.e. 44 days of sales or 65 days of COS.
96- CCC = 40 days)
97- Actual Cash Conversion Cycle
QTR.4 1996 Qtr.4 1997 Diff.

DSI 31 13 -18
DSO 42 37 -5
DPO 33 54 +21
CCC 40 -4 -44

CCC = DSI + DSO -DPO


Savings from WC Improvements
Annual savings from:
- Reduced inventory = 18*17.6 = $317 mn.
- Reduced Receivables = 5*22.1=$110 mn.
- Increased Payables =21* 17.6=$ 370 mn.

Total savings = $797 mn.


Actual 1997
Sales grew by 47%.
CCC became 44.
Profit margin increased to 6.6% from
5.1%.
Component prices decreased. Advantage
over competitors.
Dell applied JIT philosophy.
Actual 1997
Operating assets increased by $199 million
only.
Total liabilities increased by $733 million
even after repayment of LT debt.
Dell obtained $279 million from put
options.
About $500 million equity repurchased.
ST investments increased by $646 million.
Actual 1997

Dell funded 1997 growth internally, repaid


long-term debt and repurchased about
$500 million in equity through a
combination of working capital and margin
improvements.