Posted by: Kenji Hall on October 16, 2007
You’ve probably never heard of Francis McInerney. He’s the 57-year-old managing director of New York-based consulting firm North River Ventures and the author of several books on business. McInerney also happens to be the guy who made “velocity of cash” a mantra for corporate chieftains everywhere. The term refers to an equation that shows how fast a company turns a sale into cash. According to McInerney, it’s what separates the best-performing companies from the mediocre majority.
McInerney’s clientele normally sit in corporate boardrooms and the corner office of the executives’ floor. But these days there’s another constituency tuning in to his musings: Wall Street. In a mid-September report to investors, Goldman Sachs analyst Yuji Fujimori held up McInerney’s equation as a handy stock-picking tool for sorting out the good, the bad and the ugly in Japan’s high-tech industry. “Cash velocity is useful not only in medium-term investment decisions but also in building a competitive stock portfolio” when there’s little guidance from companies’ top brass, wrote Fujimori. That’s quite an endorsement from Institutional Investor’s top-rated analyst covering Japan’s consumer electronics industry last year.
And it was hardly empty praise. Fujimori paid McInerney the ultimate compliment by making cash velocity the basis of his upgrade for Matsushita Electric Industrial’s stock to “buy” from “neutral” over the short term, and for revisions to price targets for Casio Computer and Funai Electric. He also borrowed the management guru’s logic to offer a more upbeat outlook for Sony than others’ relatively bearish rants about the company’s prospects.
McInerney's formula goes like this: cash velocity equals sales receivables turnover plus inventory turnover minus accounts payable turnover. Put another way, it rates how well a company manages its working capital. Companies that rate highest in McInerney's book—-such as Apple and Dell—-have negative cash velocity. That means they collect money from retailers, dealers or distributors before having to pay their own bills to suppliers or ad agencies. They enjoy super-lean supply chains that zip products to market while preventing worrisome inventory pile-ups.
"As a rule, companies that do not turn sales into cash quickly don't do anything very well," McInerney wrote in "Panasonic: The largest corporate restructuring in history", which was released earlier this year. The worst of the lot get caught in a vicious cycle that he's dubbed the "ugly, unk-unk"-—or the unknown unknowns that leave execs wracking their brains over how to fix things.
McInerney's concept is also slightly contrarian. For manufacturers, faster production and product makeovers aren't as vital to being competitive as an operation that's tightly integrated manufacturing, services and distribution. The better coordination not only helps a company ship the latest gizmos to market without amassing inventory, it's also essential when a company has to shift gears fast to respond to a disruptive new technology, McInerney wrote. Fujimori agreed. Too often, Wall Street analysts "have monitored inventory levels closely but neglected to quantify working capital efficiency in other areas," Fujimori wrote.
The fact that Fujimori changed his outlook on Matsushita, Japan's biggest consumer electronics maker, might seem no accident. After all, McInerney based his book on the decade he spent as an adviser to Matsushita's then-CEO Kunio "Kirk" Nakamura. Nakamura managed an astonishing turnaround—-culminating in record profits—-at a time when rivals in Japan were suffering shrinking margins and profits and getting hammered by competition from low-cost Asian tech upstarts. Fujimori notes that Matsushita follows McInerney's system "to the letter." A skeptic might view McInerney's book as product placement for his own Big Idea, and Goldman's Fujimori as the gullible gawking consumer who can't help being swayed. "'Panasonic' is the poster child for what can be done for large legacy companies burdened with traditions and obsolete procedures," he wrote, in one of his over-the-top, self-congratulatory statements.
But Fujimori has done his own number-crunching. In a 37-page report, he plots graphs showing how Casio's improvements in cash velocity over more than eight years would have been a better predictor of share prices than operating profits. He explains that Sony's ability to differentiate its laptop PC products with choice tech from its video and components businesses and its determination to trim capital-intensive parts of its semiconductor division should help cash velocity and support his mid-term optimism about the company's shares, which are far below the historical highs of 2000.
And he notes that, using McInerney's metrics, the only Japanese tech company that's in the same league as IBM, Apple, Microsoft and Google is video game maker Nintendo. This week, the Kyoto-based company (with its 3,000 employees worldwide) and creative force behind the popular Wii and DS gaming consoles saw its stock rise to such heights that its market value now exceeds $85 billion, Japan's third-largest--trailing only car-making powerhouse Toyota Motor and banking giant Mitsubishi UFJ Financial Group. To Fujimori, Nintendo is a classic example of why McInerney's benchmark matters because it's "able to collect superior consumer information and has strong brand power." Heck, McInerney couldn't have said it better himself.