Short Story about Dell’s Working Capital

(Q1) Dell’s advantageous working capital policy enabled the corporation to face its current growth. The Just-In-Time inventory system and Sales built to order allowed, reduced the cash conversion cycle and minimized the amount of capital Dell needed to finance its business.

Compared to competitors, Dell working capital policy gave Dell the following advantages: * Lowest cost of inventory held - Dell saves 16. mUSD compared to Apple, 30. 8 mUSD compared to Compaq and 12 mUSD compared to IBM. * No outdated goods on the market-product assembly after customer order received * Efficient Quality control - defective materials used for final product could be identified at earlier stages of production cycle vs. ompetitors having to disassemble whole product * High inventory turnover - continual decline in Days Sales of Inventory from 1994 to 1996 contributing to a low cash conversion cycle allowing more money available in liquidity (cash) format, than being tied up in inventory management * No middle man - selling directly to consumers and placing factory sites close to suppliers avoids unnecessary mark-ups which Dell transfers into customer savings and post-sale supports * Faster collection period and Just-in-Time delivery-production cycle helped ensure nothing was made until order and payment was processed first * Q2) Dell funded its growth in FY 1996 both by internal (income from operations) and external funding. It is shown that Dell’s internal funding had a FY 1996 Net Income of 266 mUSD.

When calculating Dell’s FY 1996 Free Cash Flow before financing activities (FCF) it can be determined that Dell needed 96 mUSD in external funding. It funded this by increasing other liabilities and common stock. During FY 1996 Dell also decreased preferred stock and replaced it with common stock.This seems like a wise action as it gave Dell more decision power over the payment of dividends (and no obligations from preferred stocks) in a time where it needed to keep cash in the company to finance its growth.

Dell internally improved and capitalized on its low working capital requirements by extending payables and decreasing receivables. By taking advantage of external funding in FY 1996 Dell was able to earn higher profits from its growth. It is a good trade off to secure external funding as long as the amounts invested in the company create attractive returns. (Q3) The 1997 projected pro forma FCF would be 144 mUSD.To fund this growth it is recommend that Dell i ssue debt as it may lower Dell’s cost of capital, as Dell’s current debt/equity ratio suggests that it could benefit from more debt (cheaper financing). As a tax paying corporation, Dell will realize a tax benefit on the interest payments.

While Dell is expected to grow profitably, it is not expected to sustain a very high growth rate (~50%) after FY 1997. If Dell expects very high growth rates after FY 1997, it should issue equity (not debt) for the period with high growth rates, and while eventually buy back the equity and issue debt when growth becomes more normal again.During a period of very high growth, it would not be smart for Dell to have to pay interests. The 1997 projected pro forma Free Cash Flow before financing activities would be $144 millIn case Dell was to rely on internal funding only, its capital would need to be reduced by 144 mUSD relative to our pro forma projected capital increase.

If Dell can maintain a working capital increase at the 1996 level of 300 mUSD, it would not need any external financing.An alternative approach to reducing a need for external financing would if the operational profit margin could be increased by ~9. 7%. This growth would result in a small positive FCF.

It is recommended that Dell finance its expected growth by issuing debt while still focusing on limiting its working capital requirement. Assuming pro forma FY 1997 numbers, the following actions could be taken for 50% growth in 1997: * 100 mUSD should be added in long term debt (assuming lower growth rates after FY 1997) * The growth in working capital should be set not to exceed 400 mUSD.At current projections, ~44 mUSD in working capital needs to be reduced to achieve this target. Dell will need to increase current liabilities at a growth rate similar to current assets. This could be achieved by negotiating longer payment terms with suppliers.

Dell has around 80 suppliers and should therefore have a good bargaining power. (Q4) It is not recommended for Dell to repurchase 500 mUSD of common stock and repay the long term debt of 113 mUSD. This would equal a cash flow requirement of 613 mUSD.Assuming no other financing is possible the cash outflow would need to be covered by cash flow from operations and investment activities (assets reductions/divestments). Dell would not be able to increase its asset base in FY 1997.

Should Dell move forward with the stock repurchase and repayment of debt, further recommendations to free up cash would be to s * * * ell fixed assets (PP;E) and lease them back. If this is unsuccessful and does not provide not sufficient cash flows, Dell would need to accept negative growth until it could free up further assets (working capital). *