Accounting Information Systems and Cash Flow Management

Introduction: Cash and Shareholder Wealth

The role of the firm in the economy is to maximize shareholder wealth (Friedman, 1970), owing to the agency role that managers play, where they safeguard the wealth of investors. Given this reality, managers are obligated to seek out ways to increase the profits of their companies. There are as many ways to earn profits as there are companies, but this paper focuses on a particular approach: cash management. For a business, cash is the ultimate goal — the fungible store of wealth that shareholders seek. Yet for the business, cash is also a source of inefficiency. Unused cash on the balance sheet earns nothing, and cash sitting in short-term investments is unlikely to generate a positive real return either. Apple shareholders recently demanded that the company return some of its excess cash as dividends, precisely because of how inefficient excess cash is for a company (Popelka, 2013).

Thus, the manager is responsible for striking the right balance between spending money to earn returns and returning that wealth to shareholders. The company must acquire cash and then quickly use it to either generate more — by retaining earnings and reinvesting in the company — or by returning the cash to shareholders. For the manager, it is therefore imperative to manage the organization's cash closely. This mandate is reflected in the concept of the cash conversion cycle. The cash conversion cycle reflects the degree to which inventory is converted to cash, and how quickly that cash is converted back into goods and services. Richards and Laughlin (1980) argued that managing the organization's cash "receives less attention in the literature than long-term investment and finance decisions, but occupies the major portion of the financial manager's time and attention." They tied the concept of the cash conversion cycle to liquidity — an approach that remains relevant today — but even in companies where the overall liquidity position is not in doubt, there is a need to manage cash effectively in order to increase profits and returns for shareholders.

How Cash Affects Profits

The case of Apple makes a good starting point for understanding how cash affects profits, because of its extreme nature. For most companies, cash is a lifeblood, and managers approach it from a liquidity perspective, always seeking to ensure that the company maintains adequate liquidity. Where liquidity is a genuine concern, that approach makes sense, because creditors are superordinate to equity holders — liquidity is therefore more important to shareholder returns than it might initially appear. In most firms, accordingly, the intensive management of cash is viewed not so much as a pathway to profitability as a pathway to survival.

Apple found itself in a different situation, making billions every year. Apple did not have enough viable projects — especially given its likely very high hurdle rate for new investments — to deploy all of the cash it was generating. The company therefore parked billions in near-cash investments, some long-term. In a low-interest-rate environment, however, these investments were earning far less than the company's ordinary operations. Furthermore, some of these earnings were held overseas, and Apple was reluctant to repatriate them and pay higher U.S. tax rates. The cumulative effect on the company was to lower its return on equity (ROE), something shareholders took notice of (Le Guyader, 2014). This situation has presented a problem for other companies as well, mainly in software and technology. Cash management at this level is more about maximizing shareholder wealth through tax efficiency and finding viable uses for cash — whether investments or dividends — than it is about liquidity.

Excess cash thus creates inefficiency, and that inefficiency reduces shareholder returns by lowering the ROE the company earns. But companies cannot simply invest in inventories or assets that could lose value, nor can they indiscriminately deploy free cash flow into new businesses. There is always the risk that a company's fortunes turn, which would require renewed attention to liquidity. There are, therefore, many compelling reasons to manage cash flow as efficiently and effectively as possible — not merely to maintain solvency, but to actively increase shareholder wealth.

Accounting Information Systems Defined

An information system is simply a system by which information is gathered, stored, and disseminated. An accounting information system (AIS) is one that tracks financial and accounting data specifically; in general, the term refers to computer-based systems (Investopedia, 2014). An AIS collects data from points throughout the company and aggregates it into accounts. The system takes each individual transaction as reported — and in many cases the AIS is linked to point-of-sale terminals — in order to gather information about each transaction individually and in real time. In essence, the AIS places all transactions into ledger accounts across the entire company.

A manager using an AIS will not typically examine individual transactions without a compelling reason, but will be able to view and report on aggregated information. At their most powerful, AIS platforms operate in real time, allowing a manager to retrieve a live balance sheet at any point, showing the company's exact cash position. Many systems may not be robust enough to do this in practice, and most companies may not require data at that frequency to make sound cash management decisions. Nevertheless, the capability itself opens opportunities for managers to improve profitability through analysis of their organization's cash flow patterns.

More valuable still is the ability to use AIS data to identify trends and extrapolate future cash positions. The larger the company, the more complex this task would otherwise be. While a small business can manage this without expensive software, a multinational conglomerate requires highly sophisticated systems to provide the breadth and depth of information needed to affect overall profitability.

As with any strategic initiative, the organization must first determine its objectives, and then use available information to set a forward-looking strategy. The ideal system would not only allow managers to model future outcomes based on a historical "base case" scenario, but would also support sensitivity analysis to illustrate how different strategic choices will affect cash flow, the cash conversion cycle, and net income.

Conclusion

Without good information, managers are unlikely to make good decisions. Any information system should be developed with the objective of ensuring that managers are able to gather, process, and analyze the information they need in order to make the best possible decisions for the company. An accounting information system is not used solely for accounting decisions. Accounting is, after all, an outcome of activity. Managers use accounting information to adjust their activities, and typically they do so in order to increase wealth for shareholders.

What an accounting information system ultimately does is provide managers with high-quality, timely information they can use to make decisions — many of which will be reflected in the company's cash flow figures. On this very practical level, the AIS allows a small management team to undertake data collection and analysis that just a few years ago would have been nearly impossible. Data is power when used properly, and the same is true of accounting information systems. Managers are able to make better strategic and tactical decisions because the AIS provides them with the opportunity to understand the opportunity costs associated with their choices. That in turn enables far more effective managerial decision-making and should result in consistently better outcomes for shareholders as the prime beneficiaries of management action.

An AIS thus has a direct role to play in improving the efficiency and effectiveness of an organization's cash flow management. The fact that an AIS can incorporate a wide range of variables — including different international tax regimes — highlights how valuable it is for managers to have access not only to this wealth of information, but to its timeliness and its modeling capabilities. They receive the information in time to act on it. For these reasons, it is highly recommended that firms implement an accounting information system to provide managers with the data they need to make the best decisions regarding cash management, working capital management, taxation, the cash conversion cycle, debt management, and, ultimately, the maximization of shareholder wealth.

References

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Friedman, M. (1970). The social responsibility of business is to increase its profits. New York Times Magazine.

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Investopedia. (2014). Accounting information system. Investopedia.

Le Guyader, L. (2014). New strategies for trapped excess cash. Journal of Corporate Accounting and Finance, 26(1), 23–27.

Popelka, L. (2013). Too much cash isn't good for Apple. Business Week.

Richards, V., & Laughlin, E. (1980). A cash conversion cycle approach to liquidity analysis. Financial Management, 9(1), 32–38.

Spathis, C., & Ananiadis, J. (2005). Assessing the benefits of using an enterprise system in accounting information and management. Journal of Enterprise Information Management, 18(2), 195–210.