DELL’s Working Capital
1. How was Dell’s working capital policy a competitive advantage?
Dell has achieved low working capital by keeping its work-in-process and finished goods inventory very low. The competitive advantage Dell achieves from this is that its inventory is significantly lower than its competitors, it does not require large warehouses for stocking the inventories and Dell is also able to adapt the fastest to technology changes in the components. The competitors would find it difficult to adapt to technology changes in a short time because they have larger inventories than Dell does.
In short, Dell builds computers only when ordered and thus does not spend much capital as a result. The declining DSI means that Dell takes increasingly shorter days to sell its inventory.
2. How did Dell fund its 52% growth in 1996?
Dell needed the following amount to fund its 52% growth in 1996 (using exhibit 4&5):
Operating assets (OA) = total assets – short term investment
OA in 1995 = 1594 – 484 = 1110 Mil USD
Operating Asset to Sales ratio = 1110/3457 = 32%
Sales increased from 3457 to 5296 Mil USD in 1996. Multiplying the operating asset to sales ratio by the increase in sales 0.32 x (5296 – 3457) = 582 mil USD, which is the operating assets that Dell needed to fund its 52% growth. This increase in assets meant an increase in liabilities too, proportional to the sales. The increase in liabilities would be:
Liabilities in 1995 = 942 Mil USD
Liabilities to Sales ratio = 942/3475 = 27.1%
Increase in liabilities = 0.271 x (5296 – 3475) = 494 mil USD
So, Dell would have an increase in operating assets of 582 mil USD and an increase in liabilities of 494 mil USD.
The short investments would remain the same as it is not related to operations. Operational profit would increase with the Operating Profit to Sales ratio:
(net profit/sales) x (5296 - 3457) = (149/3457) x (5296 - 3457) = 227 mil USD
In all, we see that a sales increase of 52% has to be funded by 582 mil USD operating assets. The sales increase would also bring additional 494 mil USD in liabilities, while generating 227 mil USD of operating profit, with short term investments remaining the same at 484 mil USD. As a result, any two combinations of liabilities, operational profit or short term investments would be sufficient to offset the 582 mil USD operating assets needed to sustain the 52% sales growth.
In 1995, as shown earlier, the operating asset to sales ratio was 32%. Similarly, the ratio in 1996 was (2148 – 591)/5296 = 29.4%. The difference in the percentages is 2.54%. This decrease in operating assets in year 1996 suggests that operating efficiency was improved by the same amount. Multiplying this difference in ratio by total sales in 1996: 5296 x 0.0254 = 134.5 mil USD, this amount can be reduced from the originally forecasted 582 mil USD to give the actual additional operating asset required to fund the 52% growth: 582 – 134.5 = 447.5 mil USD.
The net margin in 1995, as shown earlier was 4.3% (149/3457). In 1996 it increased to 272/5296 = 5.14%. This net profit is an increase from the forecasted 227 mil USD (calculation shown earlier), and can be attributed to improved net margins. Also, we see an increase in current liabilities of 187 mil USD between 1995 and 1996. We also see that the sum of the increase in current liability and the net profit, of 1996, is higher than the actual additional operating asset requirement: 272 + 187 = 459 mil USD > 447.5 mil USD. Therefore, Dell funded its 1996 sales growth through internal resources, i.e. reducing its current assets and increasing its net margin.
3. 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?
For the year 1996,
Operating Assets = Total Assets – Short term Investments =...
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