Dell's Working Capital

...

- Technological Volatility of the Industry

The entire personal computers industry is extremely dynamic and fast paced. The technology that is in use today may suddenly become obsolete tomorrow. Even though Dell has managed to stay on top of this problem by ensuring very low finished goods inventory hence making it easy to quickly implement the changes required without having to dismantle the systems. Yet the prices of the old components fall every time a new technology comes in place and hence Dell has to gather new components from its suppliers to ensure they are able to match the present technology in demand.

CASE ANALYSIS

To analyse Dell’s situation we must first analyse the present business model.

Pros and cons of the Build to Order model:

Pros:

- Low finished goods resulting in low carrying and maintenance cost

- In case of defective products it is much easier and quicker to replace

- Rolling out Computers with new technology is much faster when compared to its industry competitors

- Generally overall low cash conversion cycle hence generates cash quicker

- Increase in sales due to better credit system

- Low inventory results in low total fixed assets hence this in return results in higher return on capital

Cons:

- Risk of component shortage and hence opportunity loss

- Lot of dependence on the supplier for the on time supply of quality components resulting in more bargaining power to the suppliers

- Low number of suppliers also added to the more bargaining power of the suppliers

Dell Computer Corporation had reported impressive growth for the fiscal year 1996 with its sales up 52% over the prior year. They have always financed their growth internally, that is through retained earnings, but considering they were consistently growing bigger they needed to find an optimum strategy to fund their growth. For this the first step will be to analyse how they funded their growth in 1996.

Operating Assets in 1995

= Total Assets – short term investments

= 1594 USD – 484 USD = 1110 USD

The Operating assets to sales ratio in 1995

= 1110/ 3475 = 31.94%.

Operating Assets in 1996

= Total Assets – short term investments

= 2148 USD – 591 USD = 1557 USD

The Operating assets to sales ratio in 1995

= 1557/ 5296 = 29.4%.

The decrease in operating assets to sales ratio

= 31.94% - 29.4% = 2.54%

In 1995, Dell’s sales figures increased from $3475 to $5296 in 1996. Taking operating assets as a proportion of sales we can figure out the required increase in operating assets as a percentage of sales:

(5296 - 3475) * 0.3194 = 582 million USD is required to fund the 52% increase in sales

The 2.54% decrease in operating asset means they saved:

5295 * 2.54%= 134.5 Million USD

So now the total amount they required to sustain their growth was:

582-134.5= 447.5 Million USD

Total increase in current liabilities was

939- 752= 187 Million USD

Net profit in 1996 was 272 Million USD

Hence the available fund to sustain its growth was

272+187 = 459 Million USD

This was more than the requirement of 447.5 Million USD hence we can conclude that the growth was completely internally funded.

Since Dell are predicting double digit growth in the fiscal year of 1997 as well, they need to devise a strategy to fund the growth.

Just for theoretical reasons if we assume Dell has the exactly same growth of 52% over the next year:

Hence, in 1997

Operating assets

(2148 - 591) * 1.52 = 2366 million USD

The increase in operating assets over 1996 will be (X)

2366 – 1557 = 809 Million USD

The margin of profit in 1996

272/5296= 5.136%

Assuming the liabilities as well as the net profit increases proportionately by 52% and the margin of profit remains same the increase in profit is: (A)

1.52 * .05136 * 5296= 413.44 Million USD

Total increase in liabilities would be (B)

1175* .52= 611 Million USD

Assuming they maintain the same short term investment

Short term investment (C) = 591 Million USD

Total fund available in this scenario is

A + B + C = 413+611+591=1615 Million USD

Total Fund requirement is

X= 809 Million USD

Hence it is possible to support the growth through internal resources

The same logic is followed and a simulation is done for assuming growth to be 40%, 50%, 60% and 70% to analyse the optimum working capital strategy.

Assumed Growth

40%

50%