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DELLS WORKING CAPITAL CASE

Syndicate Group 1

1. Adyansyah Patonangi 29116352


2. Marilyn P.R.L. 29116429
3. Pradipto Swatias Haryono 29116406
4. Aglentia Dwi Fitri 29116503
5. Mirco Gwozdz 29117904

Bandung Institute of Technology


School of Business and Management
Master of Business Administration
1. Company Background
Dell Computer Corporation was founded in 1984 by then nineteen-year-old Michael Dell.
The company designed, manufactured, sold and serviced high performance personal computers
(PCs) compatible with industry standards. Initially, the company purchased IBM compatible
personal computers, upgraded them, then sold the upgraded PCs directly to businesses by mail
order. Subsequently, Dell began to market and sell its own brand personal computer, taking
orders over a toll free telephone line, and shipping directly to customers.
Selling directly to customers was Dells core strategy. Sales were primarily generated
through advertising in computer trade magazines and, eventually, in a catalog. Dell combined
this low cost sales/distribution model with a production cycle that began after the company
received a customers order. This build-to-order model enabled Dell to deliver a customized
order within a few days, something its competitors could not do. Dell was also the first in the
industry to provide toll-free telephone and on-site technical support in an effort to differentiate
itself in customer service.
Dell Computer Corporation had reported impressive growth for fiscal year 1996 with its sales
up 52% over the prior year. Industry analysts anticipated the personal computer market to grow
20% annually over the next three years, and Michael Dell expected that his company, with its
build-to- order manufacturing system, would continue its double-digit growth. Although Dell
Computer had financed its recent growth internally, management needed a plan for financing the
future growth.
2. DELL Inventory Management
Dell built computer systems after the company received the customers order. In contrast,
the industry leaders built to forecast and maintained sizeable finished goods inventory in their
stock or at their channel partners. Dells build-to-order manufacturing process yielded low
finished goods inventory balances. By the mid-1990s Dells work-in-process (WIP) and finished
goods inventory as a percent of total inventory ranged from 10% to 20%. This contrasted sharply
with the industry leaders, such as Compaq, Apple and IBM, whose WIP and finished goods
inventory typically ranged from 50% to 70% of total inventory, not including inventory held by
their resellers.
Dell maintained an inventory of components. The cost of individual components, such as
processor chips, comprised about 80% of the cost of a PC. As new technology replaced old, the
prices of components fell by an average of 30% a year. Dell ordered components based on sales
forecasts. Components were sourced from about 80 suppliers in the mid-1990s down from a
high of 200 or more. Dell issued releases for a certain amount of product from a suppliers
inventory on a regular basis, depending upon the forecast. Suppliers, many of whom had
warehouses close to Dells Austin Texas and Ireland plants, delivered parts to Dell, often on a
daily basis.
As Michael Dell explained, other companies had to maintain high levels of inventory to
stock reseller and retail channels. Because we built only what our customers wanted when they
wanted it, we didnt have a lot of inventory taking up space and soaking up capital. As such,
Dells supply of inventory was significantly lower than its competitors, providing a competitive
advantage.
3. Dell Low Inventory Model as Competitive Advantage

Dell low inventory model will influence their working capital, as low inventory will result
with low working capital. Their working capital policy will reduce the amount of WIP and
finished goods inventory in its system, and will resulting in reduced the need for inventory
financing, warehousing and inventory control. Dell kept its account payable account to a
minimum volume by waiting until the customers order was received before placing the
release order with their suppliers, and because the suppliers location is near the Dell
manufacturing plants then the suppliers daily deliveries to Dell will be on just-in-time delivery.
By not receiving the parts until the last minute, Dell kept both its inventory and its accounts
payable to a minimum. On the sales side, Dell took orders directly from consumers who
normally pay with a credit card online, or over the phone. Because Dell waited until they
received the order from the customer to start building the computer, Dell kept the CCC (cash
conversion cycle to a minimum).
Table 1: Dell's CCC for each quarter from 1993 until 1995

Quarter CCC
Q193 48
Q293 40
Q393 48
Q493 56
Q194 57
Q294 51
Q394 41
Q494 41
Q195 40
Q295 40
Q395 39
Q495 35
Q196 39
Q296 43
Q396 43
Q496 40

The low inventory model will result with low days sales inventory (DSI), even compare to
the competitors DSI, Dells DSI also very low:
Companys DSI 1993 1994 1995
Dell 55 33 32
Apple 52 85 54
Compaq 72 60 73
IBM 64 57 48
from the balance sheet its known that the COGS for year 1995 is $2737m, then it can be seen
the comparison if Dell COGS is same but with competitors DSI are:
DSI 1995 Net Ending Inventory
32 (Dells DSI) $243m
54 (Apples DSI) $411m
73 (Compaqs DSI) $555m
48 (IBMs DSI) $364m
58 (competitors average $441m
DSI)
from the table, it can be seen that if Dell were to operate at Compaqs DSI level then Dell have
to increase its 1995 inventory from $243m to $555m, which is an increase of $312m. The
calculation means that Dell working capital would be increase and the inventory model will not
low as previously. When compared to the industry average DSI, Dells inventory also lower as
much $198m for the same COGS, hence the working capital also would be bigger to attain. The
main reason that Dell was able to maintain such a low level of inventory compared to their
competition has a direct result of their competitive strategy to maintain a minimum level of
inventory.
Also when take a look into the opportunity loss, the Dell opportunity loss also much smaller
than Compaq. From the case its known that when technology are being introduced, the
component cost could be reduced almost by 30%. Because Compaq had to sell off its old
inventory before purchasing new goods so opportunity loss of Compaq is 0.3 * $555m =
$166.5m when compare to the Dell inventory level of just $72.9m.
Dell policy of working with low inventory and hence low working capital led to following
advantages:
1. No obsolete goods
2. Defects in raw material manufacturers were easily weeded out
3. Lower opportunity loss
4. New superiorly technological can be easily set into the system before the market turns
over the existing inventory
5. Dell had a first move advantage in being abreast with latest technological inclusion
6. Dell achieve high inventory turnover and low inventory days which resulting in low cash
conversion cycle
4. Dell Funding for 1996 52% Growth
In its 1996 fiscal year, ended January 31st 1996, Dell sales is increasing to $5296m from
$3475m, this figure means that Dell revenue was up 52% over the prior year, whereas industry
growth is only 31%. The Dells total asset for 1995 is $1594m which is 46% from its sales, and
its operating asset were total assets less short term investment in 1995 is $1110m (1594-484)
which is 32% of its total sales
1995 As % of Sales
Total Asset 1594 46%
Operating Asset 1110 32%
then 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 1996 = $5296m * 32% = $1695m
the operating asset in 1996 is bigger then the 1995s operating asset as much $585m. Dell needs
to find the additional source fund to meet the expense in this operating asset, to achieve the 1996
52% growth.
By looking to internally source of funds, it can be seen that the liabilities less accounts
payable have increased from 1995 to 1996 as much as $494m:
1996 liabilities less account payable 1995 liabilities less account payable
$(2148-466)m - $(1594-403)m = $494m
also the profit margin for 1995 is 4.3% (149/3475 * 100), assume the profit margin for 1996 stay
the same, then the projected operational profit for 1996 is $227m
1996 projected net profit = $5296m * 4.3% = $228m
thus the total cash inflow that Dell have for 1996 is $722m ($494m + $228m), because the total
cash inflow is bigger than the required additional operating asset, then the firm can make
sufficient funding through internal sources
By looking to their asset turnover ratio, short term investment ratio and the current liabilities
ratio to sales, it can be seen as this:
1995 1996
Asset Turnover Ratio (sales/total 3475/1594 5296/2148
asset) =2.18 =2.46
Short-term Investment as % of Sales 484/3475 591/5296
(short investment/sales) =14% =11%
Current Liabilities as % of Sales 752/3475 939/5296
(current liabilities/sales) =21.6% =17.7%
from those metrics it can be seen, the way of how Dell funded its 52% growth in sales, first the
asset turnover ratio has increased from 2.18 to 2.46, which means the efficiency of the firm asset
has increasing. The short term investment percentage and the current liabilities percentage were
also decreasing which also helping Dell funded its 52% growth compare to previous year. The
summary are, Dell fund the sales growth by improving the asset turnover ratio, which is using
the asset more efficient, and another thing that they did is increasing their current liabilities.
5. How Dell Fund Its 1997 Sales Growth
It had been forecasted that the 1997 Dell sales will grow 50% to $7944m from $5296m in
year 1996, it was forecasted based on fixed liabilities versus proportional liabilities just like how
it was done in 1996. Also, including or excluding buy back of shares and payoff the long term
debt. The Dells total asset for year 1996 was $2148m which is 41% from its sales, and its
operating asset were total assets less short term investment in 1996 is $1557m (2148-591) which
is 29.4% of its total sales
1996 As % of Sales
Total Asset 2148 41%
Operating Asset 1557 29.4%
Then when the sales grow by 50% in 1997, the operating assets need to grow in a similar
proportion. Thus, the operating assets in 1997 must be:
Operating Asset 1997 = $7944m * 29.4% = $2336m
the operating asset in 1997 is bigger than the 1996s operating asset as much $779m. Dell needs
to find the additional source fund to meet the expense in this operating asset, to achieve the 1997
forecasted 50% growth.
By looking to internally source of funds, it can be seen that the 1996 liabilities less accounts
payable margin to sales is 31.7% (($2148m - $466m) / 5296). Assume that the liabilities less
account payable margin is stay the same for year 1997, then the 1997 liabilities less account
payable is $2518m (31.7% * 7944). Then the liabilities less account payable have increased from
1996 to 1997 as much as $836m:
1997 liabilities less account payable 1996 liabilities less account payable
$2518m $(2148-466)m = $836m
also the profit margin for 1996 is 5.1% (272/5296* 100), assume the profit margin for 1997 stay
the same, then the projected operational profit for 1997 is $405m (5.1% * $7944m)
1997 projected net profit = $7944m * 5.1% = $405m
thus the total cash inflow that Dell have for 1997 is $1241m ($836m + $405m), because the total
cash inflow is bigger than the required additional operating asset, then the firm can make
sufficient funding through internal sources for sales growth in 1997.
Dell have improved the working capital management to minimize it making it efficient,
and also Dell have improved the profit margin improvement, these improvement had helped Dell
to four advantage:
1. Fund growth
2. Help in repayment of debt
3. Buy back of shares
4. Fund growth with internal funds
4. If Dell Also Repurchased $500m of Common Stock in 1997 and Repaid Its Long-term
Debt How Will It Affect the Answer
Incase of repurchase of stocks and repayment of debt, the investment requirement would
shoot up by $500m to become $1091m. The already available funds are: Short-term investment
of $591m. The profit margin can be increased by 2% to yield an additional $159m in funds
(0.2*$7944m). The shortfall left is of $432m. These funds can be obtained by modifying the
cash conversion cycle. By modifying the cash conversion cycle, it can be done in three ways:
a) Reducing the inventory age
b) Reducing account receivable collection period
c) Increasing account payable payment period
Reducing the inventory age
The 1996 inventory is $429m, then the inventory as percentage of sales in 1996 is 8.1%. Suppose
the inventory as percentage of sales remain the same for 1997, then 1997 inventory is $644m.
Because Dell need additional fund of $432m then Dell needs to reduce the inventory value.
Suppose the COGS in 1997 is pro forma to the COGS as percentage of sales in 1996 which is
$6344m then the DSI of 1997 is 37 days. The DSI need to be reduce to acquire additional
$432m, the COGS per day is 17 (COGS/365=6344/365) then the NBP/COGS per day is 25
($432m/17), then the DSI need to be reduced as much 25 days into DSI equal 12 days
Reducing account receivable collection period
Assume the account receivable percentage of sales in 1996 and 1997 is same which is 13.7%,
then 1997 account receivable is $1089m. The 1997 collection period is 50 days (AR/sales per
day=$1089m/$22m), the collection period need to be reduce to acquire additional $432m. the
NBP/sales per day is 20, then the collection period need to be reduce as much 20 days for the
new 1997 collection period which is to be 30 days.
Increasing account payable payment period
Assume the account payable percentage of sales remain same for 1996 and 1997 which is 8.8%.
then 1997 account payable is $699m. The 1997 payment period is 41 days (AP/COGS per
day=$699m/$17m), the payment period need to be reduce to acquire additional $432m. the
NBP/COGS per day is 20, then the collection period need to be increase as much 25 days for the
new 1997 collection period which is to be 66 days.

If Dell are modified their cash conversion cycle using one of those three ways, then Dell
will be able to acquire additional $432m to fund the repurchased of their $500m common stock.