Tire City, Inc.

Introduction
Jack Martin, the CFO of Tire City, Inc., was preparing for a meeting with his bank to present a request
that the bank grant Tire City a five-year loan to finance anticipated growth in the company and the
expansion of the company’s warehouse facilities.
As the company is a rapidly growing retail distributor of automotive tires in north-eastern US. For the
year ended in December, 1995, TCI had sales of $23,505,000. Net income for that period was
$1,190,000. During the previous three years, sales had grown at a compound annual rate in excess of
20%. The record was a reflection of the Tire City’s reputation for excellent service and competitive
pricing.
TCI has borrowed funds from MidBank in 1991. This loan was being repaid in equal instalments of
$125,000 without any default in paying back the loan instalments. Also, in 1991, TCI had established
a line of credit at MidBank.
Analysis
Based on the information given in the case, financial health ratios are as follows:

1993 1994 1995 Performance

Current Ratio 2.03 1.92 2.03 Healthy – No threat from short term lenders
Below market average. Still in a healthy
Profit Margin 4.81% 4.90% 5.06%
position
Healthy – Good ratio for a company with
Total Asset Turnover 2.47 2.60 2.62
many assets
24.53 23.73
Return on Equity 23.87% Healthy – Above market average
% %

Based on Mr. Martin’s prediction for 1996 sales of $23,206,000 and for 1997 sales of $33,847,000
and relying on the other assumptions provided in the Tire City case, we have prepared complete pro-
forma forecast of TCI’s 1996 and 1997 income statements and yearend balance sheets.
Assumption:

 Any new financing requirement will be in the form of bank debt.

 All debt (existing and new bank debts) bears interest at the rate of 10%.
The following are the projections for the income statements based on the weighted average of
previous years multiplied by Martin’s projected sales for the given years,
 For years ending 12/31 1993 1994 1995 1996 1997
Amount in 000s
INCOME STATEMENT

Net Sales $ 16,230.00 $ 20,355.00 $ 23,505.00 $ 28,206.00 $ 33,847.00

Cost of sales $ 9,430.00 $ 11,898.00 $ 13,612.00 $ 16,401.00 $ 19,684.00
Gross Profit $ 6,800.00 $ 8,457.00 $ 9,893.00 $ 11,805.00 $ 14,163.00
SG&A expenses $ 5,195.00 $ 6,352.00 $ 7,471.00 $ 8,927.00 $ 10,685.00
Depreciation $ 160.00 $ 180.00 $ 213.00 $ 260.00 $ 306.00
Net Interest Expenses $ 119.00 $ 106.00 $ 94.00 $ 150.00 $ 164.00
Pre-tax Income $ 1,326.00 $ 1,819.00 $ 2,115.00 $ 2,469.00 $ 3,007.00
Income Tax $ 546.00 $ 822.00 $ 925.00 $ 1,076.00 $ 1,326.00
Net income $ 780.00 $ 997.00 $ 1,190.00 $ 1,393.00 $ 1,681.00
Dividends $ 155.00 $ 200.00 $ 240.00 $ 279.00 $ 338.00

BALANCE SHEET 1993 1994 1995 1996 1997

Assets
Cash $ 508.00 $ 609.00 $ 706.00 $ 856.00 $ 1,019.51
Accounts Receivable $ 2,545.00 $ 3,095.00 $ 3,652.00 $ 4,362.00 $ 5,217.00
Inventories $ 1,630.00 $ 1,838.00 $ 2,190.00 $ 2,656.00 $ 3,139.00
Total current assets $ 4,683.00 $ 5,542.00 $ 6,548.00 $ 7,873.00 $ 9,376.00

Gross plant & equipment $ 3,232.00 $ 3,795.00 $ 4,163.00 $ 5,253.00 $ 6,205.00

Accumulated depreciation $ 1,335.00 $ 1,515.00 $ 1,728.00 $ 2,149.00 $ 2,532.00
Net plant and equipment $ 1,897.00 $ 2,280.00 $ 2,435.00 $ 3,104.00 $ 3,672.00

Total assets $ 6,580.00 $ 7,822.00 $ 8,983.00 $ 10,977.00 $ 13,048.00

Liabilities
Current maturities of long
term debt $ 125.00 $ 125.00 $ 125.00 $ 125.00 $ 125.00
New Bank Debt $ 1,283.00 $ 1,417.00
Accounts Payable $ 1,042.00 $ 1,325.00 $ 1,440.00 $ 1,787.00 $ 2,138.00
Accrued Expenses $ 1,145.00 $ 1,432.00 $ 1,653.00 $ 1,986.00 $ 2,381.00
Total Current Liablities $ 2,312.00 $ 2,882.00 $ 3,218.00 $ 5,181.00 $ 6,061.00
Long-term debt $ 1,000.00 $ 875.00 $ 750.00 $ 1,232.00 $ 1,342.00

Common Stock $ 1,135.00 $ 1,135.00 $ 1,135.00 $ 1,598.00 $ 1,817.00

Retained Earnings $ 2,133.00 $ 2,930.00 $ 3,880.00 $ 4,198.00 $ 5,170.00
Total Shareholders' equity $ 3,268.00 $ 4,056.00 $ 5,015.00 $ 5,796.00 $ 6,987.00

Total Liabilities $ 6,580.00 $ 7,822.00 $ 8,983.00 $ 10,977.00 $ 13,048.00

Using the set of pro-forma forecasts, the future financial health of Tire City as of the end of 1997 is
given in the table below,

1995 1996 1997 Performance

Current Ratio 2.03 1.52 1.55 Decline in current ratio
Profit Margin 5.06% 5.03% 5.07% Healthy
Total Asset Turnover 2.62 2.57 2.60 Slight decline in performance
 24.03 24.06
Return on Equity 23.73% Increment – Healthy
% %
Debt-Equity Ratio 0.13 0.14 0.17 Increasing debt

The performance of TCI will be roughly same in the years 1996 and 1997. There will be a slight
decrease in the performance when it comes to total asset turnover and the current ratio. However,
profit margin and return on equity will increase and therefore remain healthy.
Decision
As a lender, we would be willing to loan TCI funds for warehouse expansion and financial and
financial growth. Based on the current and projected figures, TCI seems to be improving overall with
slight causes for concern with their current ratio and total asset turnover, which can be overlooked.
Strong financial capital structure and debt-serving capacities of TCI adds to our decision. Ratios are
also relatively consistent.

Case 2 - Dell’s Working Capital

Introduction

Dell Computer Corp. is a company that makes, sells, and maintains computers. The firm sells
computers directly to clients and produces them once they have placed an order. Dell's build-to-
order business allows them to invest far less in working capital than its competitors. It also allows
Dell to get the full advantages of lower component costs and offer new products more quickly. Dell
has developed rapidly and has been able to fund that development internally through effective
working capital management and profitability. The necessity of working capital management in a
quickly developing company is highlighted in this scenario.

Problem:

Over the last few years, Dell Computer Corporation (“Dell”) has experienced continuous
increases in sales, regularly outpacing the rest of the computer industry. In the most recent fiscal
year of 2016, Dell achieved an impressive sales growth of 52%, relative to the industry
benchmark of 31%. With industry analysts anticipating the personal computer market to grow
20% annually over the next 3 years, Dell is expected to continue its recent trend of strong
performance. Nevertheless, inventory shortages have limited Dell’s full growth potential these
past few years. Although their build-to-order inventory system has resulted in an incredibly
efficient asset turnover, this strategy also limits the company’s sales when consumer demand
exceeds the supply of inventory on hand. As a result, Dell must devise a plan for how to better
manage and finance its future growth.

Options:

1. Status quo: no change in current management of working capital

2. Finance future growth internally
3. Finance future growth externally using short-term liabilities

Funding Requirements: Is external funding needed

To begin, we looked at Dell's sales growth performance in comparison to the industry during the
previous three years, as this was when Dell began to move its focus from only growth to profitability
and liquidity strategies. Dell has outpaced the industry on average by a factor of 1.71 since then.
Given that industry experts estimate the personal computer sector to expand at a pace of 20% each
year, we used this multiple to project a growth rate of 34.29 percent for Dell (See Appendix I). Dell is
anticipated to generate revenues of $7.112 billion in 1997 based on this growth rate.
Then, for each income statement item, we used the Percent of Sales Method to anticipate a pro forma
income statement for 1997. (See Appendix II). Instead of using numerous data points as a baseline,
just 1996 percentages were used to better reflect the company's current operational situation. Net
income for 1997 was anticipated to be $357.22 million based on this prediction. The same procedure
was used to calculate the common-size of each of Dell's asset accounts, as well as accounts payable,
accrued, and other liabilities, which we believed would rise in tandem with sales. As a policy, the
remaining balance sheet elements were assumed to have stayed constant from 1996 to 1997, with
retained earnings equaling the sum of year-end retained earnings in 1996 and 1997's predicted net
income. Based on these calculations, it was calculated that Dell would require $57.38 million in
external money to complete the project assumed growth rate of 34.29 percent As a result, in order to
finance this growth, Dell would need either a policy change or external investment, therefore ruling
out options 1 and 2.
Working Capital
Both current assets (about 40% of sales) and current liabilities (roughly 20% of sales) have been
positively connected with net sales, increasing as a percentage of sales. This demonstrates that Dell's
short-term assets and liabilities have not altered to reflect the company's expansion. However, the firm
only keeps 1% of its revenues in cash (as of 1996) and is at least doing a good job of reinvesting its
earnings into prospective possibilities rather than simply sitting on cash.
Looking at Dell's quarterly performance in previous years, we can observe a similar trend: despite
minor quarterly changes, the company's working capital has witnessed a net improvement. Days Sales
Outstanding (DSO) has dropped from 58 in Q194 to 42 in Q496, Days Sales of Inventory (DSI) has
dropped from 55 in Q194 to 31 in Q496, and the Cash Conversion Cycle (CCC) has dropped from 57
in Q194 to 40 in Q496 (See Appendix IV). The shift in Days Payables Outstanding is once again the
most striking issue: a continuous drop from 56 days (Q194) to 43 days (Q396), followed by a rapid
increase decrease to 33 days (Q496).
Dell is throwing up an interest-free financing option by paying their suppliers so promptly, with the
only net advantage being maybe stronger relationships with their suppliers. This is financially
imprudent, because there would be no cost to raise the days payable outstanding if there were no
foregone discounts. An additional $157 million of money is created by extending the repayment time
back to their historical average of 43 days from the most recent quarter's 33 days (See Appendix V).
Dell will be able to raise the $51 million in external finance required to support their planned
expansion without incurring any additional fees. The fundamental underlying assumption here,
however, is that there is no cost for extending the repayment period to the historical average. If this is
not the case, Dell should use short-term borrowing to fund its EFN.
Ratio Analysis

Profitability
Dell's profitability has been improving in recent years. The net profit margin grew from -1.25 percent
in 1994 to 5.14 percent in 1996, narrowly missing the company's goal of 5%. (See Appendix VI).
Furthermore, Dell's ROA grew from 10.90 percent in 1995 to 14.54 percent in 1996, and its ROE
increased from 26.54 percent to 33.48 percent in the same year (See Appendix VI). Dell has clearly
performed extraordinarily well across the board in terms of profitability. Despite the positive results
in 1996, Dell has been plagued by component shortages. Dell may become even more lucrative by
rectifying this inventory mismanagement with the adoption of an EOQ system.
Liquidity
In recent years, Dell has demonstrated their ability to meet short-term financial obligations. This can
be observed with their current ratio, which has increased from 1.95 in 1994 to 2.08 in 1996 (See
Appendix VI). Furthermore, Dell’s quick ratio has also been steadily increasing as it reached 1.63 in
1996, demonstrating Dell’s ability to pay off short- term liabilities without relying on the sale of
inventories (See Appendix VI). Although Dell has been maintaining healthy liquidity in recent years,
their days of purchases in accounts payable has diminished significantly from 52.35 in 1995 to 38.97
in 1996 (See Appendix VI). This once again reaffirms that Dell is paying its suppliers much quicker
and as a result, are missing out on a potential lucrative source of funding.

Financial Leverage
Dell's financial leverage has been decreasing in recent years. In reality, their debt-to-equity ratio
fell from 1.44 in 1995 to 1.21 in 1996, and their debt-to-income ratio fell from 0.59 in 1994 to
0.55 in 1996. (See Appendix VI). Dell does not appear to be overly reliant on debt when it comes
to funding. Given these modest levels of financial leverage, Dell may be able to take on
additional debt without threatening default. They might, for example, prolong their Days Payable
Outstanding (DPO) and therefore profit from an interest-free period. source of funding. However,
this is assuming there is no discount being foregone by increasing the DPO.

Fiscal Year 1994 1995 1996

Liquidity
Currant Ratio 1.95 1.95 208
QUick Ratio 154 1.57 1.63
Daily Purchases NA 7.70 11.96
Days of Pumhases in Accounts Payable NA 52.35 38.97
Turnover
Asset Turnover 2.52 2. 8 2.47
Receivables Turnover 6.90 6.46 7.29
Inventory Turnover 11.09 9.34 9.86
Days in Inventory 32.91 39.07 37.03
A/R Period 52.22 56.51 50.04
A/P Period NA 6.79 9.?3
Financial Leverage
Dedt Ratio 0.59 0.59 0.55
De6t-Equity Ratio t42 144 1,21
Equity Multiplier K42 2.44 2.21
Profitability
Profit Margin 1.25% 4.28% 5.14P
Return on Assets NA 10.9096 14.54%
Return on Earnings NA 26.54% 33.48P
DuPont ROA -3.16%' 9.35% 12.66°$
DuPoni ROE -7.64% 22.85% 27.95°4

Inventory Management

Dell's inventory is much lower than those of its competitors. Its days supply of goods declined from
55 to 32 days between 1993 and 1995, while its nearest competitor, IBM, had a 48-day supply in
1995. As a result, Dell's current inventory management strategy is to purchase less goods, more
frequently, in order to reduce inventory holding costs. Dell, on the other hand, bears the danger of an
inventory shortfall, as happened in the fourth quarter of 1996.

We propose that Dell keep its work-in-progress inventory on a just-in-time basis due to their close
proximity to component suppliers. Dell, on the other hand, will be able to cut costs while retaining
adequate inventory to fulfil typical demand by transitioning to an Economic Order Quantity inventory
management system.

Total inventory costs, not only holding costs, are lowered utilising the EOQ approach, which Dell is
now focused on.

Dell will also be able to better manage demand variations while keeping additional carrying costs low
by making orders consisting of the average demand on top of a level of safety stock. However, to find
the ideal quantity, this model must be watched and modifications made as needed.

This is because keeping too much inventory puts Dell at danger of obsolescence inventory write-offs,
which happened in April 1993 when Dell sold off $76 million in surplus inventory. Overall, the EOQ
model will assist Dell in better managing demand while preserving, if not increasing, their low-cost
inventory strategy.

DPO Calculations:
When DPO=33 then A/P= 520.6
When DPO=43 then A/P= 678.35
Diff erence(Extra funds)= 157.76

Recommendation:

Given Dell's existing financial situation and the external capital required to support their planned
expansion, the company should fund its growth and inventory using short-term liabilities. Dell should
do so by extending their Days Payable Outstanding, which results in an interest-free source of
capital.Additionally, Dell could implement an EOQ inventory management system to reduce total
inventory expenses while also lowering the total number of liabilities required to maintain future
growth.