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Dell’s Working Capital

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

 Howwas Dell’s working capital policy


a competitive advantage?

 Howdid 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?
Dell’s 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 Compaq’s DSI =


$2737 * (73-32) / 360 = $312 million
Dell’s 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
Dell’s Competitive
Advantage
3) Quicker adoption of new technology
 Dell’s 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
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
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.