Submitted by: Salil Aggarwal PGP I, Section: E Brief Case Analysis 1

Submitted to: Dr. Yogesh Maheshwari Finance-I (Oct-Dec 2013) November 26, 2013

Dells Working Capital

The Case: To analyze the working capital policy of Dell. The Company: After being founded in 1884, it first sold upgraded IBM computers directly to business customers, then began to market and sell its own personal brand directly and later also added the retailer route. Dell used a build to order manufacturing process, thus keeping low finished goods and work in process inventory. Their inventory ranged from 10-20% whereas competitors from 50-70%. With 1% of market share in 1990 company grew in one big leap and moved to within top 5 in worldwide market share in 2 years. Dell reported increase in sales by 52% in 1996 and its recent growth was internally financed. Shifted its focus from P&L statement to managing ROIC and Cash conversion cycle. The Issue(s): 1) To understand the competitive advantage of Dells working capital policy. 2) How was it able to fund the 56% in 1996 internally. 3) Whether it can fund around 50% growth in 97 inte rnally. The Analysis: 1) Dells working capital policy was of competitive advantage because: a) Since Dell basically used a build to order model it always had less inventory which meant it was less expensive to promptly shift to latest technology, could provide latest systems at same price unlike competitors and it could provide consumers with a personalized computer b) High generation of cash because of low CCC, more sales can be done on credit basis, low inventory with low fixed cost meant higher ROCE. c) Since case mentions a 30% decrease in component price, if we calculate the opportunity loss of its competitors Apple and Compaq (assuming cost of sales per day to be same) with DSI 54 and 73 respectively, the excess of inventory holding comes out to be (54-32)*7.5mn = $165mn and (73-32)*7.5 = $307.5mn therefore opportunity loss is 0.3*165 = $49.5mn (Apple) and 0.3*307.5 = $92.25mn (Compaq). 2) Sale grew from $3475 to $5296 (growth of 52.4%). Total assets in 1995 were $1594 i.e. 46% of sales, total assets apart from short term investment are $1110 which is about 32% of sales. Thus when the sales grow by 52%, these assets need to grow in a similar proportion. Thus, for 1996 it becomes = $5296mn * 32% = $1694mn. Therefore increase in operating asset must be $580mn, to meet the growth in 1996. If we look at the sources of funds, the liabilities less accounts payable have increased by $491mn and the projected operational profit at 4.3% of projected increase in sale gives additional $227mn (0.043*1.522*3475 = $227mn). Thus the firm can make sufficient funding through internal sources. Therefore total inflow is $227+$491 = $718mn which is more than the required $580mn hence growth in 1996 would have been internally financed. 3) Total Asset SI = $1557mn (1996), as a % of sales it becomes 29.4%. Required increase in (Total Asset SI) to meet 50% 1997 growth = 0.294*0.5*5296 = $778.5mn. Cash flow from change in (total liability accounts payable) = 2523 (2148-466) = $841mn. Net profit in 1996 as percentage of sales is 5.14%. Therefore cash flow from operating profit is 0.0514*1.5*5296 = $408mn. Therefore total inflow is $408mn + $841mn = $1249mn which more than the required $778.5mn. Hence Dell can fund its 1997 growth internally.