Dell’s Working Capital

This case looks into how Dell Computer Corporation was able to turn around itself from a loss through a shift in company focus and effective working capital management. During its early years, Dell was so focused on growth, that it neglected two other major financial considerations essential for a company’s growth: profitability and liquidity. This paper describes the strategies undertaken by Dell to be able to recover from the loss, and in the process, attempts to answer the following questions: .

What working capital management strategies were employed by Dell? 2. How did these strategies work to Dell’s advantage in order to achieve recovery? 3. How can Dell achieve growth sales while being profitable? 4. What financial plan should Dell implement in order to finance its future growth? To address these, the group used a framework that leads to better understanding working capital management, its components (i. e. accounts receivable, inventory and accounts payable) and its implications to a business.The balance sheet and income statement of Dell proved that the company indeed has a positive working capital and good financial ratios.

The timing of Dell’s strategy to shift to a different business model and focus not only on growth but also on liquidity and profitability as well is perfect. They were able to gain bigger market share and improve the company’s standing in the market. To sustain its growth, it is recommended that Dell stick with its direct-sell strategy as it has been proven to be one of their business advantages.

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In addition to these, Dell must be able to internally fund its financing need from the expected growth.Several recommendations on generating funds have been outlined which Dell could take into consideration. DELL COMPUTER CORPORATION Case Context Dell Computer Corporation, one of the world’s top computer brands, approached the market in 1984 with a build-to-order business model – a business model that enabled the company to compete head-on with the big players in the computer industry. Six years after its inception, Dell went in an attempt to capture more sales and spur growth when it decided to break from its direct business model and employ mass market retailers as indirect distribution channels.This move by Dell brought tremendous revenue growth and placed the company as one of the top 5 computer companies in terms of market share. However, focus on revenue growth alone proved to be not enough. In Dell’s case, an effective management of working capital could have spared the company from incurring a $76 million loss in 1993, which were mainly caused by the pullout of the company’s notebook line, charges relating the sell-off of excess inventory and restructuring charges to consolidate European operations. This realization pushed the company to focus on liquidity and profitability as well, together with growth.Changes geared towards this shift in focus have been instituted in the company, which eventually led to Dell’s recovery, in time for its re-entry to the notebook market and introduction of Pentium-based computer systems. Problem Definition The goal of this case study is to analyze how Dell’s shift in focus – from being focused solely on growth to being concerned also on liquidity and profitability alongside with growth – led to the recovery of the company from the loss it incurred. Specifically, this case aims to answer the following questions: 1. What working capital management strategies were employed by Dell? . How did these strategies work to Dell’s advantage in order to achieve recovery? 3. How can Dell achieve growth sales while being profitable? 4. What financial plan should Dell implement in order to finance its future growth? Case Framework With the objective of understanding the success brought about by Dell’s focus shift, the initial step is to understand the role of working capital management in a firm’s ultimate goal of maximizing shareholder value. Next is to identify the areas involved in working capital management and determine how these are measured.The figure below summarizes the approach used by the proponents of this case study. Analysis Dell’s working capital management strategies Companies must measure risk, develop, and implement strategies for maintaining a positive cash flow. This strategy is called a working capital management strategy. The goal of an efficient working capital management strategy is to balance current assets against current liabilities so a company may meet its short-term obligations and maintain operating expenses. Proper working capital management proves essential in the avoidance of bankruptcy by helping a business balance needs with obligations.Two major components of a working capital management strategy are current assets and current liabilities. # Working capital is defined as the difference between current assets (most liquid assets, i. e. cash or assets that can be quickly converted into cash within one year) and current liabilities (obligations due within one year) which may yield either a positive or negative amount. The working capital represents the operating liquidity of a firm, or the margin of protection after short-term liabilities have been met. Hence, a positive working capital is essential for a company to continuously meet its operational needs.This aspect of financial management was overlooked by Dell during its early years. Like any start-up, Dell initially focused on growth that it succumbed to the conventional wisdom that direct sales would never be more than a niche market and moved partly into the retail channel, offering its products through PC superstores, like CompUSA, and power retailers, including Wal-Mart, Best Buy and Staples. # The company grew, with sales reaching $2. 8 billion in the fiscal year ended Jan. 31, 1994, but at a net loss of $36 million.It was in 1993 when Dell realized that while growth is an extremely important driver of shareholder value, there are other aspects that need to be considered. This brought about Dell’s shift in focus – from just growth to cash conversion cycle, which consists of inventory, payables, receivables and cash flow from operations. This refocus was also communicated not only to the upper management but to the entry-level employees as well to emphasize its importance. In order to align itself with this shift in focus, Dell had to employ several strategies that would maximize the cash conversion cycle.In an article written on Dell by Lawrence M. Fisher for Strategy-Business. com, he outlined the notable strategies and its implications, as follows: 1. Going back to the direct-sales-only business model and build to order manufacturing process * Little or no finished-goods inventory * Little parts inventory, which means less impact of losses due to falling prices for components as new technology replaced the old * Positive cash flow, as customers paid more quickly than Dell paid its suppliers 2. Withdrawal from the retail channel * Got back the control on prices for consumers Were able to focus on improving the company’s capabilities in field sales to large organizations and telephone sales to small businesses and consumers 3. Segmentation of organizational structure based on regions, keeping only product development central. * Regional management was empowered to run their units as stand-alone companies * Accelerated growth, as the segment gets more focus * A new vendor certification program was instituted to ensure quality and improve delivery performance Efficacy of Dell’s working capital management strategiesDell is a company that is very light on its feet, it suffered its first loss in 1993 and bounced back the same year. The working capital strategy of Dell, which deals with current assets and current liabilities, is perfect for their industry considering that they have a good quality product. Direct selling improves their working capital by giving them better profit margins for their products. It gives them the margin that the retailers would have made. Their built to order manufacturing process solves their problem with liabilities and the risk of products being obsolete or sold at great discounts.Their customers pay for the products before a finish product is manufactured. This solves the problems that might occur with current liabilities. When they withdraw from the retail channels, they were able to maintain a low level of finished goods inventory. They maintain 10 to 20 % while industry is around 70 %. They did not have to worry about the perceived opportunity loss of the retailers. These level of inventories are easier to balance with the current liabilities to maintain a good level of cash flow. Empowering their regional units made them more aware of the profit and loss statements.From the smaller units it would make the whole company more profitable and steadfast it minimizing losses. The training of suppliers will make to supply chain faster. It will make the Cash conversion shorter. To highlight the changes in Dell’s strategies and operations towards recovery. We used a year-on-year comparison between 1993 and 1994, the cost of goods sold in relation to sales in went up by 7. 22%. Operating expenses also went up by 1. 04%. This translates to 207. 50 million dollars in terms of efficiency in cost of sales relative to sales and 29. 78 million dollars for the decrease in efficiency in operating expense.Total cost of income due to the decrease in efficiency in using raw materials and lowering operating expense equals 237. 28 million dollars. This means that if Dell had the same percentage of cost of goods sold and operating expenses relative to the sales in 1992 and 1993, Dell would have saved the said amount. Now in 1994-1995, the cost of goods sold in relation to sales went down by 6. 17% percent, while operating expense also went down by 2. 36% both year on year. This translates to 214. 27 million dollars in terms of efficiency in cost of sales relative to sales and 81. 0 million dollars for the increase in efficiency in operating expense. Total cost of income due to the increase in efficiency in using raw materials and lowering operating expense equals 296. 17 million dollars. This means that if Dell had the same percentage of cost of goods sold and operating expense relative to the sales in 1993 and 1994, Dell would have losses equal to the said amount. From 1993 to 1996, Dell has managed to consistently decrease its Days Sales of Inventory (DSI), Daily Sales Outstanding (DSO), and Daily Payables Outstanding (DPO), hence resulting to shorter cash conversion cycle (CCC) and increasing Working Capital (WC).The shorter the cash conversion cycle the better the company is off because it has to lock up cash for a relatively smaller period of time. As you will see from the exhibit below, the average DSI for each year improved from 47 days in year 1993 to 35 days in year 1996. This means that it takes only around 35 days for Dell to turn its inventory into sales. Likewise, improvements can also seen in Dell’s DPO from 52 days in year 1993 to 41 days in year 1996. The number of days it takes for Dell to pay its creditors became shorter. Despite this big eduction in DSI and DPO, the improvement in the days it takes for Dell to collect money from those customers in credit improved only around 5 days. From Exhibit 2|  |  |  |  | | DSI| DSO| DPO| CCC| Q193| 40| 54| 46| 48| Q293| 44| 51| 55| 40| Q393| 47| 52| 51| 48| Q493| 55| 54| 53| 56| | 46. 5| 52. 75| 51. 25| 48| Q194| 55| 58| 56| 57| Q294| 41| 53| 43| 51| Q394| 33| 53| 45| 41| Q494| 33| 50| 42| 41| | 40. 5| 53. 5| 46. 5| 47. 5| Q195| 32| 53| 45| 40| Q295| 35| 49| 44| 40| Q395| 35| 50| 46| 39| Q495| 32| 47| 44| 35| | 33. 5| 49. 75| 44. 75| 38. 5| Q196| 34| 47| 42| 39| Q296| 36| 50| 43| 43| Q396| 37| 49| 43| 43|Q496| 31| 42| 33| 40| | 34. 5| 47| 40. 25| 41. 25| Taking into consideration the current ratio of Dell for the year 1994 to 1996, the current ratio is not improving very well. The ratio is the same  for 1994 and 1995 which is 1. 95 but improved a little on 1996 and became 2. 08. This means that the company has twice the amount of current assets to pay its current liabilities. But since computer industries rely on big amount of inventories and these inventories tend to become obsolete and lose it value very quickly, analyzing just the current ratio is not enough. Inventories are assets that can be considered to have certain risk.The fast paced technological advancement pose a threat on the inventories that one company has. Especially today that the competition is very tight and companies has a lot of cash which they can use for research and development to be always ahead of the competition. Removing the inventories from the equation would lead us to the quick ratio for Dell. The quick ratio is also good since the result for Dell is greater than 1. The ratio were 1. 39, 1. 42 and 1. 46 for the year 1994, 1995 and 1996 respectively. This means that even without the inventories, Dell can still pay its obligations. Decision and Justification Business Model and InventoryWith what happened in 1993, where they changed the business strategy from direct selling to strengthening retail sales, which led them to a loss after consistently having a net income of 5 %. Dell should focus on direct selling and just use the internet for retail marketing because of the following reasons: 1. Dell started their company with direct selling. They try to know what the client wants and they try to make a computer that the client needs. They should focus on informed and sophisticated clients that know what they want and can wait for what they want. These clients are the big companies that purchase in bulk. . They should have a low level of inventory, which is contrary to what the retail market demands. The high level of inventory can hurt their working capital because of the risk involved in inventory in the personal computer industry. They may have to sell in huge discounts to convert their inventories into cash. Since inventory carrying costs take significant investment, dell must try to reduce the level of inventory. Lower level of inventory will result in lower days’ inventory on hand ratio. Therefore lower values of this ratio are generally favorable and higher values are unfavorable.However, inventory must be kept at safe level so that no sales are lost due to stock-outs. 3. If marketing thinks that retail sales is necessary for sales growth, they should make a system where retailers adapt to their built to order manufacturing system. They should make use of the internet system to boost retail but they should maintain the system that the order should be placed first before manufacturing the finished product. 4. The low level of inventory will also give a higher quick ratio which is preferable because it means greater liquidity. However dell’s quick ratio should not reach high levels , say 4. 0, is not favorable to the business as whole because this means that the business has idle current assets which could have been used to create additional projects thus increasing profits. With the majority of sales coming from direct selling, they will be able to manage the risk in inventory and be able to have a better working capital because the current assets would be more liquid. They will also have more cash, because most of these customers will be paying a certain percentage of sales before they manufacture. These will help them further attain growth.The direct selling model will also help them have a database of customer information that will give them the advantage for a repeat client relationship. The industry growth projection in 1997 is 20 % and Michael Dell projected that they will surpass industry growth once again. By using common size analysis to get AFN, it shows that they will just need 189. 34 million on the third year but they won’t need additional funds in the first two years. They should be able to fund for the first two years. If they use credit to satisfy the funding needed on the third year their current ratio would be 1. 4 and their quick ratio would be 1. 27 as shown in exhibit 2. They outsource the manufacturing of components, which is a major cost for the finished goods. With almost just in time manufacturing they maintain a low level of inventory and they will be able to fund their own growth with credit. Action Plan Computer industries are expected to grow over the next few years. With this, management should find ways on how they can finance this growth. The financing can be done either internally or externally. Internally, Dell could do the following: * Maintain a certain Level of InventoriesTechnologies tend to change rapidly. Holding a large amount of inventories makes the probability of resulting to bigger losses is higher. Dell should maintain their level of inventories to be less than 20% of the total assets. They would be able to do these by direct sales marketing and just in time manufacturing. * Further improve DSO, DSI and DPO These ratios are the Key Performance Indicator of the company’s working capital. Dell should balance  the level on how they extend credit to customers to make sale, inventories to sell and maximum possible length of days to pay its suppliers. Continue to Monitor its Liquidity and Profitability Dell should continue to monitor its liquidity and profitability. The company’s initiative to shift its focus from growth to liquidity and profitability is considered as a very good strategy. They should try to source better by developing their suppliers to fit the direct sales marketing strategy and just in time manufacturing system. Liquidity defines the company’s ability to meet its short-term obligations and profitability, on the other hand, measures how profitable the company is.This monitoring would enable the company to ensure, not only that they get enough profit to finance their operation, but they have necessary funds to pay its debts. Dell should use quick ratio to measure it liquidity. * Introduce Other Products Dell should also find other products that will be responsive to the needs of their clients. Future readings suggest that they are doing well with the selling of servers and computers for storage. These will reduce the risk of new technological advances that might hurt the personal computer industry.