DELL INC.
Analysis of cash Flow Statement
Dell’s net income decreased by 42% in 2010
and recovered strongly by 83% in 2011. Though
the net income in 2009 was strong the quality
of earning’s ratio was 0.76, on operating cash
flow, which is less than 1 which denotes a poor
quality of earning mainly triggered by a large
pay out of accounts payable.
On the contrary, in 2010 the company has a dip in
net income but the quality of earnings ratio was
2.72 on operating cash flow and was 2.46 on a
free cash flow basis. These contrasts in income,
profits and changes in quality of earnings could
be an indication of “Earnings management” by
the company, which needs to be looked into.
From an operating cash flow point of view, the
company has managed exceeding well triggered
by increasing payable days supported by
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effectively collecting the financing receivables
and reducing receivable days. FY 2011 had a good
net income from operations, highest in all 3 years
but the quality of earnings showed a drop from
2010 and reported QER of 1.5 on operating cash
flow basis and a QER of 1.32 on free cash flows.
If, we include the “purchase of financing
receivables” to arrive at free cash flow then the
QER is 1.16.
a) Dell is showing lot of volatility especially
reversal in several accrual items over 2009-2011
which indicate poor earnings quality. This might
be due to aggressive accounting policies or lot
of one-offs.
b) The Free Cash flow (CFFO-capex) is pretty
stable in 2010 and 2011 (around $3.5 bn) but
shows a large change from 2009 ($1.45 bn).
c) There is strong evidence of accrual earnings
management. Accruals show large variations in
pretty much every item from receivables to
payables to deferred revenues to inventories and
other assets indicating both large accruals and
deferrals which reverse subsequently. Especially
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when net income falls in 2010 to $1.43 bn from
$2.48 bn in 2009, it is accompanied by increase
in receivables by more than $1 bn and increase
in payables by $2.8 bn.
d) Revenue accounting in 2010, when net income
falls, is also aggressive as deferred service
revenue increase is only $135 mn in 2011
compared to $663 mn in 2009 and reversal to
$551 mn in 2011.
e) While net income is down more than 40% in
2010 over 2009, cash from operations is up
more than 106% which clearly indicates
earnings management, most likely classification
shifting.
f) The cash flow from operations seem higher than
net income (except in 2009, but still very
healthy). This should ideally indicate good
earnings quality but lot of volatility in actual
components indicate clear classification
shifting.
g) Most of the working capital investments in 2010
seems to have been clubbed with acquisition of
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business in 2010 of $3.6 bn showing a strong
operating cash flow but most likely, overstated
while expenses are hidden within cash flow
from investments. Even in 2011, some
investments in working capital is pushed down
to investing activities (purchase of receivables)
to show a good operating cash flow.
h) It is also observed that despite healthy free cash
flows every year and more than $13 bn cash in
balance sheet, Dell is still a net issuer of debt of
more than $1 bn every year (gross proceeds
increasing every year). In 2009, it had
repurchased a good amount of stock ($2.8 bn)
but haven’t done too much since. This could be
since Dell might be getting ready for a big
acquisition and grow inorganically.
i) Dell also runs a very active treasury which
shows gross purchases and sale of investments
of $1 bn every year. However even after having
a cash balance of 5x that of net income, there is
no mention of other income in cash flow
statement, which is likely to be a big part of
profits. This seems to have been included in net
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income but not adjusted in operating cash flow
statement, which is not correct and
indicate classification shifting to overstate operating
profits and also operating cash flows.
J. Accounts Receivable including Financing
Receivables balance has gone up by $1,745M in 2010
and another $1,416M in 2011. This indicates that the
quality of receivables is not good. The company has
been making significant provisions for doubtful
receivables, with an average of $374M annual
provision during this period. This is more than 15% of
the net income during this period!
K. While in 2010 and 2011, the company has
invested almost equal to what matured, it was
2009 that the company invested far less than what
matured ($1,584M versus $2,333M).
This, coupled with the fact that the company had a
sudden increase in Accounts Payable in 2010
indicates some stress in their cash position. The
company has also taken new debt in all the three years
($1,519M, $2,058M and $3,069M, respectively in
2009, 2010 and 2011) without making any significant
repayments, except in 2011. This further indicates a
poor cash position. And I am wondering if all of this
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was done to finance $2,867M worth of Repurchase of
Common Stock in 2009, and another $800M in 2011.
In summary Dell has managed its cash flow
efficiently, both during the periods of low and
high net income levels. It has effectively
maintained a high level of operating cash flow to
exhibit a good operating health while investing in
growth. It has been raising short term debt to
support operations, which potentially is low in
cost compared to cost of equity while buying
back stock to ensure higher returns to its
investors. However, for analysts, the above
differences have to act as a red signal, and need to
be keenly looked into, for probable mis-
representation.
