dell
...ent with long-term debt. The major drivers causing the decrease in liquidity are increasing inventory levels and increasing receivables. In contrast to the liquidity ratio, the current and quick ratio are indicating that Dell’s liquidity position is actually improving (refer below). Because the company’s receivables and inventory balances are increasing at a level that is greater than its payables and accrued expenses, it causing the current and quick ratios to improve. Exhibit 1. VI. Profitability Measurement Suggestion A. Dell should measure their profitability using return on equity (ROE). This ratio, earnings after tax divided by the total equity, measures how much profit the company is bringing in for every dollar of equity. See Exhibit 2. Exhibit 2. B. Components Changes in Profitability Metric 1. From examining the changes within the components of ROE during the 1994-1996 period, it is evident that profit margin has vastly improved. Following 1993 and Dell’s sell off of excess inventory, the company adopted a new metrics for reporting profit and losses which was center around each business unit. Vital changes occurred between these years that promoted growth for example the company set goals for ROIC and CCC as well as improved their internal system for forecasting, reporting and inventory control. These changes were also combined with the introduction of Pentium technology into their notebook personal computers. C. Components Observations 1. With all these internal changes, total asset turnover shows a decline in 1995 and increase in 1996 due to the relationship that exists between sales and total assets. For the ratio to increase the portion of sales would have to increase at a greater percentage over total assets. Although, relative to yearly comparisons this ratio declines and improves for Dell, with regards to the industry the company’s overall turnover ratio is better than their major competitors based on the DSI figures supplied in the case packet. The equity multiplier, a measure of invested capital, is slightly decreasing. This is because the company has decided to fund future growth through increasing equity. The ratio declines because the portion of equity is increasing quicker than and at a greater rate than the portion of debt. This move towards greater equity financing poses less risk to Dell due to the fixed expenses that are tied to debt financing. Thus, analysis of total ROE over the three years shows that profitability is increasing. D. Impact of Equivalent DSI on Profitability Metric 1. See Exhibit 3. If Dell’s DSI in 1995 were equal to that of Compaq’s (73), then inventory would have been 311.71 million dollars greater than it was. This means that total assets, specifically inventory would have increased by this amount, assuming that COGS was equally dispersed among the four quarters of the year as noted in the income statement in the case packet. Total asset turnover will decrease with a higher DSI which will directly decrease the ROE. Without knowledge of other aspects of the ROE equation, it is hard to determine the overall effect of increased DSI. However, just by decreasing total asset turnover and holding the other equations constant, it is clear that ROE will decrease. Lower profitability and an increase in total assets will set the need for increased financing, through either debt or equity. As mentioned above, while debt funding is efficient, it also carries high risk due to fix expenses. Equity is relatively high and as noted in the beginning of the case past growth had been financed internally and management looked to plan future growth via external funding. If Dell had been in this position in 1995, serious consideration should have been taken when planning this growth. Internal analysis of processes to reduce costs and optimize efficiency should have been examined prior to seeking additional financing. Dell’s management should have realized that their DSI figure was not in line with that of industry averages. Exhibit 3. VII. Growth in...