Corporate Finance

Estimation of Working Capital 
 275

1993 1994 1995

Dell Computer 55 33 32

Apple Computer 52 85 54

Compaq Computer 72 60 73

IBM 64 57 48

The efficient usage of working capital helps in providing internal funding for growth and also avoids the

costs of obsolete inventory that companies face when the technology changes. Amazon.com, like Dell, receives

cash payments upfront for its products but pays its suppliers about two months later. Further, Amazon has

modest inventory requirements because it carries only popular titles and its distributors like Ingram and

Baker & Taylor are responsible for carrying inventories of less popular items. Traditional booksellers like

Barnes & Noble must carry substantial inventories spread across warehouses and in each store. This is a

source of competitive advantage for Amazon.^1

To illustrate the impact of reduced inventory on a company’s competitive position, assume that a company’s

cost of sales is Rs 100 crore, its days’ supply of inventory is 30 days and that for the nearest competitor is 60

days. The additional inventory the company would have to hold if it were to have as long a DSI as its competitor:

= (Cost of sales) × (Competitor’s DSI – DSIself)/360 days

= Rs 100 (60 – 30)/360 crore

= Rs 8.33 crore

Improvements in the components of the cash conversion cycle can be translated into cash equivalents by

multiplying the improvements in the components (in days) by daily savings.

Cash conversion cycles of some international companies (for 1999, in days)
Company DSO DII DPO CCC
Exxon 28.37 15.52 44.54 (0.65)
Microsoft Corp 35.05 0.0 117.58 (82.52)
Bethlehem Steel 26.48 90.13 35.38 81.22
Nucor 30.89 39.09 21.69 48.29
Compaq 62.64 26.75 49.93 39.45
Dell 35.52 6.32 56.52 (14.69)
Source: C S First Boston.

THE LINK BETWEEN OPERATING CYCLE AND

SUSTAINABLE GROWTH

Define self-financeable growth rate as the rate at which a company can sustain its growth through the revenues

it generates without seeking outside capital.^2 As pointed out earlier, operating cash cycle is the length of time

a company’s cash is tied up in working capital before that money is collected from customers. Other things

remaining constant, the shorter the cycle, the faster a company can redeploy its cash and grow from internal

(^1) Of course, if Barnes & Noble also launch an online outfit, the advantage would not be unique to Amazon.com
(^2) Churchill, Neil and John Mullins (2001). ‘How Fast Can Your Company Afford to Grow?’, Harvard Business Review, May.