Financial Ratios For Dell Inc example essay topic

Financial Ratios for Dell Inc. Jose Gonzales Finance 544-Finance for Managerial Decision Making Kevin Boyle (FAC) March 9, 2005 Abstract Financial Ratios for Dell Inc. Team D selected Dell Inc. as our company for the team project. Why was Dell chosen? Dell Inc. with annual revenue of $41.4 billion, is a premier provider of computing products and services. Because of its direct business model, Dell was the leading seller of computer systems worldwide and the number one seller in our customer segments in the United States during calendar year 2003.

Michael Dell founded the company in 1984 on a simple concept of selling computer systems directly to customers. Using this technique, Dell could best understand customer needs and efficiently provide the most effective computing solutions to meet those needs. Dell's climb to market leadership is the result of a relentless focus on delivering the best customer experience by selling computer system and services directly to customers. Dell, a Delaware corporation, is based in Round Rock, Texas and conducts operations worldwide through wholly owned subsidiaries.

The company's business strategy combines its direct customer model with a highly efficient manufacturing and supply chain management organization and an emphasis on standards-based technologies. This strategy enables Dell to provide customers with superior value high quality, relevant technology customized systems; superior service and support; and product and services that are easy to buy and sell. (Form 10 K, 2004) A company with an annual revenue of $41.4 billion must be financially sound, right? The answer is... ". not necessarily!" However, there are tools available that will help determine if our selected company is financially sound. Ratio analyses are those tools used to evaluate the performance of a business and identify potential problems. Financial Ratios Financial ratio analysis can teach so much about Dell's accounts and business.

For example, using ratio analysis, we can conclude the profitability of Dell. We can also determine if Dell has enough money to pay its bills. Ratio analysis can check whether Dell is performing better this year than it was last year. Additionally, ratio analysis can alert us if Dell is doing better or worse than other businesses selling the same or similar products. web 1.1 lists the ratios we feel are important for our selected company.

They are profitability, liquidity, debt management, and asset management. Profitability The first category is profitability. Has Dell made a good profit compared to its turnover? For example, return on equity determines the rate of return on Dell's investment in the business. As an owner or shareholder, this is one of the most important ratios. Why is it important?

It answers the question, "Is Dell making enough of a profit to compensate for the risk of being in business. To calculate this ratio, divide net profit by equity. Then compare the return on equity to other investment alternatives, such as stocks or bonds. web on assets is the next ratio we will review. It is considered a measure of how effectively assets are used to generate a return. Return on assets shows the amount of income for every dollar tied in assets. It is an indicator of how profitable Dell is.

This ratio is used annually to compare Dell's business performance to industry norms. Earnings before income taxes divided by net operating assets is how the return on assets ratio is calculated. The gross profit margin ratio indicates how efficiently Dell is using its materials and labor in the production process. It shows the percentage of net sales remaining after subtracting cost of goods sold. A high gross margin indicates that a business can make a reasonable profit on sales, as long as it keeps overhead costs in control. This figure answers the question, "Is Dell pricing its goods or services properly?" A low margin, especially in relation to industry norms, could indicate you are under pricing.

A high margin could indicate over pricing if business is slow and profits are weak. Gross profit divided by total sales is the formula. Operating margin is another measurement of management's efficiency. It compares the quality of a company's operations to its competitors. To calculate the operating margin, divide operating income by the total revenue.

The net profit margin tells how much profit a company makes for every $1 it generates in revenue. Profit margins vary by industry, but all else being equal, the higher a company's profit margin compared to its competitors, the better. Net income after taxes divided by revenues is how net profit margin is arrived. web The second category of ratios is liquidity indicators. Does Dell have enough money to pay its bills? Current ratio is a liquidity indicator and is the standard measured of any business' financial health. This ratio will tell if Dell is able to meet its current obligations by measuring if it has enough assets to cover its liabilities.

The standard current ratio for a healthy business is two, meaning it has twice as many assets as liabilities. Current assets divided by current liabilities is the formula. Like the current ratio, the quick ratio measures a business' liquidity. Many financial planners consider it a tougher measure than the current ratio because it excludes inventories when counting assets. It calculates a business' liquid assets in relation to its financial health. The optimal quick ratio is 1 or higher.

To calculate this ratio, divide current asset less inventories by current liabilities. web Management The third category of ratios is debt management. Debt management is an indicator of Dell's vulnerability to risk. Creditors often use these ratios to determine the ability of the business to repay loans. The debt to equity ratio indicates how much the company is leveraged (in debt) by comparing what is owed to what is owned. A high debt to equity ratio could indicate that the company may be over-leveraged and should seek ways to reduce its debt. The formula is total liabilities divided by total equity.

Current liabilities to equity indicates the amount due creditors within a year as a percentage of the owners or stockholders investment. The smaller the net worth and the larger the liabilities, the less the security for creditors. Normally, a business starts to have trouble when this relationship exceeds 80%. This ratio is calculated as current liabilities divided by equity. web ratio / Asset Management The last category we selected is asset management.

Asset management measures how the business uses its fixed and current assets. Asset turnover ratio, (or revenue / total assets), is an overall measure of how effectively assets are used during a period. It is computed by dividing net sales by average total assets. web Financial Detial. htm The sales / net working capital ratio measures the number of times working capital turns over annually in relation to net sales. This ratio should be viewed in conjunction with the assets to sales ratio. A high turnover rate can indicate over trading. Also, it may indicate that the business relies extensively upon credit granted by suppliers or the bank as a substitute for an adequate margin of operating funds.

Sales divided by net working capital is the computation for this ratio. The interest coverage ratio has huge implications for bond and preferred stock investors in particular. This financial ratio tells the investor the number of times the earnings before interest and taxes can pay, or 'cover', the interest payment the company makes on its debt. To calculate the interest coverage ratio, divide EBIT (earnings before interest and taxes) by the total interest expense. web Comparisons As we have seen, ratios measure the relationship between two or more components of the financial statements. However, ratios have greater meaning when the results are compared to the industry standards for businesses of similar size and activity.

When comparing ratios with those of other companies, it is important to ensure you are using the same equation in the calculations. A ratio may vary in importance depending on the business type, the industry category it belongs or its location. For example, regional differences such as labor or shipping costs can affect the result of a ratio. Sound financial analysis always requires scrutinizing the data used with the ratios and examining the circumstances that generated the results. web tools / calculators /Financial analysis using ratios. htm? Prin...

Dell's competitors are Compaq Computer, Digital Equipment Corporation, Gateway Incorporated, Hewlett-Packard Company, International Business Machines Corporation, Mitac International Corporation, NEC Corporation Sun Microsystems Inc. and TCL Corporation. Table 1.2 documents common industry comparisons for Dell. SIC: 3571 Table 1.2 Line of Business: ELECTRONIC COMPUTERS Asset Range: All Asset Ranges within SIC Group Industry Quartiles 2003 2002 2001 Statement Sampling: 45 Statement Sampling: 87 Statement Sampling: 114 Solvency Upper Dell Lower Upper Dell Lower Upper Dell Lower Quick Ratio (times) 2.81 0.6 1.7. The attention will now focus on interpreting Dell's trends for its financial figures. The first category we will discuss is the profitability ratios. Return on Equity (ROE) The market for computers was on the upturn in the years 2000 and 2001, which pushed Dell's ROE to its historically high.

In year 2002, Dell's ROE was reduced to approximately 26.50% after the 911 terrorist attacks. Thereafter, ROE leveled off to approximately 42.50%. However, it is still providing investors with a considerably high and constant return. This is a favorable trend, considering most competitors have been harshly hit since 2000.

Return on Assets (ROA) Dell reported a steady ROA for the last two years that topped around 13.50% in the years 2003 and 2004. These results were caused by the upturn in the technology sector. The tremendous growth in the computer industry during the 1998 and 1999 from the Y 2 K euphoria can be attributed to the high ROA for the computer industry in those periods. Dell's ROA was approximately 15% in years 2000 and 2001, which is higher compared to other companies in the industry. However, it appears constant year after year. Return on Investment (ROI) The ROI is perhaps the most important ratio of all.

It is the percentage of return on funds invested in the business by its owners. In short, this ratio tells the owner whether or not all the efforts exerted into the business has been worthwhile. Except for the year 2002, where ROI was 332.88, Dell's ROI has been increasing since 2000. In year 2004, Dell reported a 740.2 ROI, which tells its owners that the company is more profitable every year. Gross Margin The gross margin tends to remain stable over time. Significant fluctuations can be a potential sign of fraud or accounting irregularities.

The gross profit informs an investor the percentage of revenue / sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Since 2002, Dell has a gross margin of 0.018, which is an indicator that it is stable. Operating Margin During the last five years, Dell 'operating margin averaged 8%. Operating margin was a lot lower in 2002 (5.74%), from a lower demand in that year. However, in 2003 and 2004 the operating margin was higher (8.25%).

This may be contributed to the recovery from the economical recession caused by the 911 events. Net Profit Margin The net profit margin ratio indicates profit levels of a business after all costs have been taken into account. A decline in the ratio over time may indicate a margin squeeze suggesting that productivity improvements may need to be initiated. In some cases, the costs of such improvements may lead to a further drop in the ratio or even losses before increased profitability is achieved.

Dell's net profit margin has been consistently over 6% except for 2002 where it dropped to a 4%. Quick Ratio Dell was very consistent and scored high marks in years 2000 and 2001 in terms of quick ratio, a measure of liquidity. Most of the years, Dell's quick ratio was above 1% showing a higher level of readily convertible current assets to discharge off its current liabilities. But in the last three years it has worsened and has been under 1% indicating strains in Dell's current assets. Potential creditors use this ratio because it reveals a company's ability to pay off debts under the worst possible conditions. web and Working Capital Current ratio for Dell has been hovering around 1.2% for most of the five years, except for the last two years when it plummeted quite sharply to 1%.

In the last two years, companies experienced zero working capital. The zero working capital reduced the cash requirements causing the current ratio to significantly decrease. Dell's ultimate goal is a 1% ratio where current assets equal current liabilities. In the past, the company kept more current assets, which was an unfavorable sign for bankers. Current ratio is used as a measure of a company's ability to survive over the near term, by measuring its ability to meet obligations with available funds.

A current ratio of 1.0 means that the company could theoretically survive for one year, even if it made no sales. web ratio / Working Capital / Total Assets (WC / TA) A firm with negative working capital is likely to experience problems meeting its short-term obligations, because there are simply not enough current assets to cover them. In 2003 and 2004, Dell's working capital was zero in both years. The firm did not have enough current assets to meet its short-term debt obligations. Current Liabilities / Equity This leverage ratio has been moving between 1.6 and 1.70% for the last five years. The exception was in the year 2000 when this ratio deviated from its mean to 0.98%.

A ratio of. 5 or higher may indicate inadequate owner investment or an extended accounts payable period. Care should be taken not to offend Dell's vendors (creditors) since this factor affects Dell's ability to conduct daily business. Total Debt to Equity Dell has a very reasonable debt / equity ratio of around 0.1 and is at par with the industry average. The ratio increased to 0.11 in 2002, when the company undertook a long-term debt to finance its operations. Generally, any company that has a debt to equity ratio of over 40 to 50% should be observed more carefully to ensure there are no liquidity problems.

The Debt to Equity Ratio measures how much money a company should safely borrow over long periods. web Long Term Debt to Assets Dell's average was 0.04 from 2000 to 2002, and lowered to 0.03 in 2003 and 2004. A great sign of prosperity is when a balance sheet shows the amount of long- term debt has been decreasing for one or more years. It refers to money the company owes that it does not expect to pay off in the next year. Long- term debt consists of things such as on corporate buildings and / or land, as well as business loans. web Assets The average for the last five years has been between 2.1 and 2.3 for Revenue / Total Assets, an asset management ratio. The higher a company's asset turnover, the lower its profit margin [and visa versa]. The asset turnover ratio calculates the total sales [revenue] for every dollar of assets a company owns. web Capital A firm with negative working capital is likely to experience problems meeting its short-term obligations because there are simply not enough current assets to cover them.

By contrast, a firm with significantly positive working capital rarely has a ratio that is a good test for corporate distress, and rarely has trouble paying its bills. In 2000 and 2001, Dell's revenue / working capital was over 10. It climbed up to 87 in 2002. Please note in year 2003 and 2004, it was (3,933.78) and (157.58) respectively. Interest Coverage Ratio A metric used to measure the ability of a company to meet its debt obligations is the interest coverage ratio. It is the ratio of a company's profits before payment of interest and income taxes to interest on bonds and other contractual long-term debt.

The interest coverage ratio indicates how many times interest charges have been earned by the corporation on a pretax basis. Since companies are obligated to make interest payments and would be forced in to bankruptcy if they did not, this ratio measures a margin of safety. Dell reported this ratio only in 2003 and 2004. For 2003, Dell reported a ratio of 179.06, and 267 for 2004. The Times Interest Earned Ratio shows how many times earnings will cover fixed-interest payments on long-term debt. It means that Dell began making fixed-interest payments on long-term debt in 2003 from its long-term debt acquired in 2002 to finance its operations.

Financial Condition of Dell Although Dell's gross margin dollars are increasing, this increase offset by the granting of excessive employee stock options has placed investors in a mathematical vice. With 320 million shares now owed to employees, this wage debt increases $320 million for every $1 dollar increase in Dell's stock price. A mere $5 increase would erase Dell's entire reported net income for the most recent year. Dell now has 3 billion shares outstanding, including the employee stock options.

The entire gross margin for the most current year is therefore equivalent to a $2 change in the stock price. Dell has clearly become a 'watered stock". What few investors realize is the company took a tax deduction for wages on its tax return for options exercised and retired in excess of $3 billion. None of this amount was charged to the publicly disclosed earnings we see.

Therefore, earnings are a mirage as Dell has effectively removed its biggest cost of doing business from the earnings statement via a legal accounting loophole. This wage expense deduction has also allowed the company to eliminate its federal income tax liability on current product sales, conserving more than $1 billion in cash in the most recent year. This is because this wage deduction for stock options exercised and retired now exceeds the taxable income from product sales. Since employees are taxed on options exercised as normal wage income, even if the stock is not sold, the IRS correspondingly allows the company to take a tax deduction.

Most technology companies do not have adequate profits to fully utilize this deduction, yet Dell, with its large profits; can utilize most of the deduction. Another little understood unique risk to Dell, is the company is speculating on its own stock in the options market. It is betting both that it will not go above a certain price and it will not fall below a certain price. These are two separate speculations. The company's assumption is that the stock will trade within a certain range and that they will be able to pocket cash from premiums paid by these investors when the options expire worthless.

The company justifies this activity by saying it is a good way to generate cash to contribute to financing the needed stock buybacks to reduce dilution from the effect of the employee stock option program. If losses are incurred the company will cover them by issuing more shares. This step is not required to be reflected as a liability on the balance sheet nor a cost to the income statement. losses. The Dell Corporation is also issuing significant amounts of restricted stock for various purposes, causing further dilution of existing shares. This is noted in its SEC filing available at web Another important trend is the company has doubled the amount of sales for financing, $1.8 billion for the most recent year ended. This implies new risks, especially given Dell's focus on high- end Windows NT based web server products.

Dell has been slow to offer Linux based systems, which now enjoy broad acceptance in this key market and offer significant cost savings advantages to customers. Although Dell had a bright beginning, it has clearly compromised its financial future from the use of these financial practices, resulting in a 'watered stock. ' Parish & Company strongly support any efforts by the SEC to prohibit companies like Dell from conducting stock buybacks while they are simultaneously engaging on speculations on there own stock in the options markets. web Kathleen's Part Potential Problems While the current assessment is Dell is very strong financially, the company must be aware that competitors are making all efforts to obtain its market share. Dell is expanding the types of products offered to include items such as LCD televisions and MP 3 players. Both of these items are rather new to the market. Introducing these f products to its production line adds a whole new list of competitors.

Sony, Toshiba, Sharp, Phillips, Hitachi, Mitsubishi, and Apple are just a few of the large competitors that manufacture these products. Since these are not customized products, customers are mainly concerned with pricing and options of these items. It may be challenging to Dell to achieve the profitability and efficiency levels for this new extended product line if it uses the same strategies it has for computers. With these types of items, consumers can walk into a variety of retail stores and walk out with the item he / she wanted. Since these items are often bought more on impulse than computers, Dell may not achieve the desired level of success it has with computers.

While Dell believes the direct model is the most effective business model, this may prove to be an inappropriate approach for items other than computers. It may be difficult to segregate all the costs associated with the production of these new items; however, it is very important for the firm to further analyze the specific results of the sales and production of new products. This will allow Dell to determine whether the company is profitable and to establish how the ratios of these product lines compare with its competitors. It is critical that Dell recognize competitors have a significant amount of resources dedicated to these types of products. Therefore, the growth plan and anticipation of growth share within this particular IT line must make considerations for competitor developments (University of Phoenix, 2003, p. 85). Dell realizes that one of its weaknesses is low research and development spending and without additional investment of resources in this area, Dell could be surpassed by some of its competitors in more than just this product line.

Currently the company only spends approximately 1% of its total sales on research and development while competitors are spending from 5% to 14% of total sales on research and development. Another potential problem in the company is the service area. A weak service position may cause Dell to lose existing and potential customers. Consumers want to be sure that the necessary support is available if problems arise with the functionality of the products.

Although manuals are provided with the products, many times customers call the customer service center for assistance. This area requires further development by Dell. Dell's reputation of poor service compared to its competitors is a challenge. One additional area that could cause problems for Dell in the future is the low inventories.

Although large inventories of technological equipment can lead to inventory becoming obsolete before it is used, maintaining too low inventory levels can cause shortage costs. This may lead to delayed production and extended turnaround times for production (University of Phoenix, 2001, p. 171). Customers who require their products quickly may take their business elsewhere. Also, as noted on Data Monitor. com, Dell realizes that a change in the pricing of the components it uses for constructing products can result in a noticeable change in earnings. Key Management Initiative As noted above, Dell has taken the initiative to enter into new product markets.

The Company views the continuance of expanding its product markets as a large opportunity (Datamonitor. com). While Dell feels that this expansion would help increase business and enhance the firm's competitive edge, there are some very important considerations to make. Based on the financial ratios for 2004, Dell is in a much stronger position than its competitors in the ratio measurements of solvency, efficiency, and profitability. As for solvency, Dell has the ability to invest more of its assets trend favorably with competitors.

The high efficiency ratios indicate the company is working very close to its capacity. Additionally, the high profitability ratios note the company could slightly lower prices to gain an even greater market share. Considering all of these ratios, the company is in a very good position to expand its product market financially. As for non-financial considerations, Dell should be concerned about the number of product lines it offers. This idea of the company entering the market and causing prices to drop while value increases is known as the "Dell Effect" (Datamonitor. com).

Dell must carefully monitor each product line separately to assure that the actual performance, profitability, and customer satisfaction can be measured appropriately. A company cannot assume that it will excel in every area. Shifting too much focus away from the main product lines can cause other competitors to gain market share. Also, cutting prices too low can result in a loss rather than profitability. Several companies have been creating these other products for years. Dell must be prepared to end a product line if profitability, efficiency, and solvency ratios are too far out of the range of the rest of the industry.

The firm is well established and known for producing a good product at a fair price and must beware of jeopardizing this reputation. Conclusion

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