Financial Management II

Dells
Capital

Working

Case Analysis
The case highlights the importance of Working
Capital Management in a rapidly growing firm like
Dell.
SUBRATA BASAK (MP15043)

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Financial Management II

Executive Summary
Dell Computer Corporation has seen extraordinarily growth: a 52.4% revenue increase
and an 82.6% profit increase in 1996 which is significantly higher than industry
performances. In 1996, Sales rose to $5.3 billion, profits to $272 million, and the total
asset increased by 35%. Much of this success is due to management principles of buildto-order model. The case highlights how the build-to-order philosophy was central to the
Dells success. The case also highlights the importance of Working Capital Management
in a rapidly growing firm like Dell.

Introduction
Dell Computer Corp manufactures sells and services high performance personal
computers compatible with industrial standards. Dell has created a unique model within
its industry: it pioneered the build-to-order computer business at a time when no one
thought that the average customer would have been willing to wait for the arrival of a
computer that he or she had not even seen. The built-to-order model enables Dell to have
a much smaller working capital requirement compared to its competitors. It also allows
dell to enjoy the benefits of reduction in component prices as well as it allows the
company to introduce the new technology more quickly as compared to its competitors.
Dell was first in the industry to deliver customized products within a few days. While
competitors were maintaining high levels of inventory to stock resellers and stock
channels, Dell focused on customer customization of products and supply to them when
they wanted it, thereby saving on huge inventory cost.
When the component cost was reducing, due to technological advancements (Price of
components fell by an average of 30% a year, 1996) Dell was able to utilize it to pass on
the savings to customers, by providing them comparative products at cheaper price.
After the launch of Pentium processors in 1994, Dells customer connect helped it
anticipate demand for newly developed Pentium based system. It was able to get 75% of
its sales from product with Pentium models alone by FY96. It didnt have to dismantle its
existing PCs, which made it less costly and move quickly to capture the market. During
Roll out of PCs with new OS technology Dell was much faster than competitors. In case of
defective products, it had quicker time to market to replace the products. Dell was also
generating cash by maintaining low cash conversion cycle. Dell had a low inventory with
low fixed assets which help it to achieve high return on capital employed.

Problem Statement
1. Dell has a competitive advantage which has been created by their working capital
policy. How Dells working capital policy was created a competitive advantage?
2. Second question is how did Dell fund its 52% growth in 1996?
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Financial Management II
3. Can 52% growth rate which is higher than the industry (31%) be sustainable in
1997 as well? Can they fund such growth rate internally?

Analysis & Solution

Following table shows various analyses from annual statement of Dell for FY94, FY95 and
FY96. The current asset has grown by 86.7% and current liability has grown by 74.5%
from 1994 to 1996. Current ratio and quick ratio have improved to 2.08 and 1.46
respectively which shows Dell has enough cash to meet their short term obligation. Cash
conversion cycle has improved in FY96 compared to FY94, but it has deteriorated with
respect to FY95.
Particulars
Current Assets
Current Liabilities
Net Working Capital
Current Ratio
Quick Ratio
CCC (yearly avg.)
Property,
Plant
and
(Operating Fixed Asset)
Net Operating Asset

Equipment

1996
1957
939
1018
2.08
1.46
41.25
179.00
450.00

Net Investment in OC
NOPAT

211.00
268.10

Free Cash Flow (FCF)

57.10

Net Income

272.00

Shareholder's Equity

973.00

ROIC/ROE
Sales

Inventory

0.28
5296.0
0
4229.0
0
429.00

Inventory Turnover
Receivables Turnover
Payables Turnover

9.86
7.29
9.08

Cost of Sales

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1995
1470
752
718
1.95
1.24
38.50
117.0
0
239.0
0
56.00
149.1
0
93.10

1994
1048
538
510
1.95
1.00
47.50
87.00

149.0
0
652.0
0
0.23
3475.
00
2737.
00
293.0
0
9.34
6.46
6.79

-36.00

183.00

471.00
-0.08
2873.0
0
2440.0
0
220.00
11.09
6.99

Financial Management II
Net Working Capital Turnover
Operating Current Asset (OCA)
Operating Current Liability (OCL)

5.20
1210.0
0
939.00

Net Operating working Capital (NOWC)

271.00

4.84
874.0
0
752.0
0
122.0
0

5.63
634.00
538.00
96.00

Dell commands a working capital advantage over its competitors and it can be seen in
Table A, which contains DSI of Dell and its competitors. One way for us to quantify Dells
competitive advantage is to calculate the increase in inventory Dell would have needed if
it operated at competitors DSI level.
Using Dells cost of sales (COS) for 1995 contained in Exhibit 4 and the information on DSI
contained in Table A:
Additional inventory at Compaqs DSI = (Dells COS) (Compaqs DSI Dells DSI)/360 days
= [($2,737)(73-32)]/365 = $308 million.
Additional inventory at Apples DSI = (Dells COS) (Apples DSI Dells DSI)/360 days =
[($2,737)(54-32)]/360 = $165 million.
Additional inventory at IBMs DSI = (Dells COS) (IBMs DSI Dells DSI)/360 days =
[($2,737)(48-32)]/360 = $119 million.
Also looking at the important ratios, we can tell that Dell has a good CCC and stable
turnover ratios but Payables turnover ratio has increased which shows that the company
has started paying off to its creditors faster. The company can reduce it CCC by differing
the payment to suppliers to some extent. Though FCF is declining, it is not necessarily a
bad thing if the company is re-investing all of their cash in business expansion.
Overall the company has a good potential of funding the growth internally since it carries
good amount of investments too which can be liquidated if needed.
On comparing Dells performance in 1996 as to 1995, the sales increased from $3475
million to $5296 million. Hence, a growth of 52.4% is reported.
1995
TOTAL ASSETS

In $ million
1594

AS a % of Sales
46

(-) short term investments

484

14

OPERATING ASSETS

1110

32

Operating assets are 32% of sales in 1995, to determine the operating asset contribution
in 1996, its ratio to sales should remain intact. Thus, the operating assets in 1996 will be
= $5296 million * 32% = $1694 M
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Financial Management II
Operating assets in 1996 = $1694 million; Operating assets in 1995 = $1110 million;
Funds needed = $584 million
Sources of Funds:
The liabilities less accounts payable have increased from 1995 to 1996
= $ (2148-466) (1594-403) million = $494 million
Net Profit as a % of sales in 1995 = 149*100/3475 = 4.3%
The projected operational profit = $5296 million* 4.3% = $227 million
Thus, we can see that the cash inflow ($721 million) is more than the required cash
outflow, it can be inferred that dell got enough money to fund its growth internally in
1996.
It can be seen that the asset turnover ratio has increased from 2.18 to 2.46. This means
the efficiency of the firm has increased. The current liabilities as a percentage of sales
have decreased from 21.6% to 17.7%. Therefore, the liabilities have reduced.

Parameter

1995

1996

Asset Turnover ratio

2.18

2.46

Short
term
investment
as
percentage of sales
Current Liabilities as a percentage
of sales

14%

11%

21.6%

17.7%

Thus, Dell funded its 52% growth in sales mainly by increasing its asset efficiency,
reducing its current liabilities and decreasing its short term investments in comparison to
the earlier year.
Can Dell grow sustainably in 1997 as well from their internal fund? Let us
assume the required growth rate for FY97 would be same as FY96 i.e. 52%. If we consider
the same cash conversion cycle for FY97 similar to FY96, 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
52% hike in revenue gives the projections as below:
Year

Sales

1996 ($
mn)
5296
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Percenta
ge
Increase
52%

1997 ($
mn)
[projected]
8050

COGS
Gross Margin
Operating
expenses
Operating Income
Other Income
Taxes
Net Income

4229
1067
690

Year

1996 ($
mn)

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

52%
52%

377
6
111
272

Financial Management II
6428
1622
1049
573
0
169
404

Days

1997 ($
mn)
[projected]
55
591

726

44

1189

429
156
1957
466
473
939

31.15

654
156
2645
835
473
1308

55
591

37.45

37.7

Hence additional operating asset of $688 million required to sustain the growth. The
increase in the current liability acts as source of funds, which is $369million. Estimated
increase in net profits is about $132 million to reach the figure of $404 million. The shortterm investment is assumed to stay the same as year 1996 i.e. $591 million. Hence we
can safely say that the growth will be internally funded.

Conclusions
Cash conversion cycle is the index that measures efficiency of working capital
management. Reduction in cash conversion cycle leads to a better position of working
capital management. Decrease of cash conversion cycle days may be an outcome
following elements: decrease of days that cash is tied up in inventory and accounts
receivable and delaying of due dates of accounts payable. Each one of these activities
results in positive balance that can be employed in development financing. Their build to
order model facilitates the low cash conversion cycle. The key advantages that Dell has
got due to this model are:
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Financial Management II

Low finished goods, low carrying costs.

It could integrate new technologies quicker than its competitors because it built
a PC after getting an order.
It could generate cash by maintaining low cash conversion cycle.
Low inventory with less fixed assets led to a higher ROCE.

Due to this efficiency improvement, Dell could generate enough funds to grow. Dell has
grown (52%) significantly better than industry (31%) and the growth is funded internally.
We can also conclude that with same level of cash conversion cycle, Dell can achieve
again 52% growth in 1997.

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