Management accounting is to accounting what a Michelin star dinner is to street food. It is like taking all the elements of what makes street food great, and putting it together in a way that makes you go wow. Management accounting is accounting principles applied practically to build a better business, and act as an engine of business growth.
Here is what we will cover in this guide:
- What is management accounting
- What is a management accounting system
- What is included in management accounts (with examples)
- Types of management accounting
- The importance of management accounting for a business
- The difference between management accounting and financial accounting
What is Management Accounting?
Every organization has goals to achieve and objectives to meet. These goals & objectives could be strategic or direct, long or short term and financial or otherwise.
Management accounting is the process by which these goals can be defined, analyzed, quantified, understood and communicated across the board. This would include business metrics and KPI reporting, financial reporting, company's financial health and budgeting of the company's resources.
Here are the 8 things to know about management accounting:
- Facilitating financial information: This is the main objective of management accounting. It fetches data and presents it to the management to help them with various procedures in the organization.
- Cause and effect assessment: Besides presenting the information, management accounting also inspects the figures and stats revealed from the information. It helps with recognizing losses and investigating them thereon.
- Utilizing exclusive tools and techniques: There are certain special tools and techniques that management accounting uses. This is done to get the most out of the information generated.
- No fixed rules: While speaking of techniques, management accounting does not have a fixed set of rules, conventions, or guidelines to apply these techniques. The application depends and varies according to the circumstances and the issues observed.
- Attainment of goals: When the management has access to the historical data, it is easier for them to realize the targets, take measures to curb losses, and perform other essential tasks skillfully.
- Enhanced performance: A detailed analysis of financial reports can provide insights into the overall performance of the business. This can drive performance improvement by identifying the right levers.
- Forecasting: This is also one of the major characteristics of management accounting. Based on the produced reports and thorough examination, managers may be able to forecast the company's future health.
- Catalyze efficient decision-making: It must be noted that management accounting only facilitates a piece of in-depth information and not the decisions, per se. This is to say that the management can decide the course after assessing the information obtained but management accounting does not directly contribute any kinds of decisions to the company.
Functions of Management Accounting
There are many functions that management accounting fulfills, but its main purpose is to help an organization's management team improve its organizational performance through better decision making. Management accounting is intended to help the management team to carry out business and activities more easily with the relevant financial information.
Provide and Modify Data
Management accounting is an important data source for management planning. The accounts and documents contain a large number of data on the past progress of the company and are a prerequisite for making future forecasts.
It also helps in rearranging and compiling this data to group them in a way that is eased out for a better understanding.
Communicate and Interpret Data
Management accounting also serves as a crucial mode of communication. There are various levels of information required by the different levels of management. This information is then analyzed for meaningful planning and decision-making.
From the top-level that requires a concise format of information to the lower levels that need the detailed reports, management accounting builds a bridge of communication within the enterprise.
Eases Planning and Organizing
Organization’s management needs concrete information for formulating essential policies for the company. Management accounting facilitates the process and helps organize data to assist with organizing.
Attempting a Future Forecast
Forecasting is vital as it leads to some crucial questions. With the data available at hand, the company may decide the necessary course of action.
Should the company look at diversifying itself into different segments?
Is there a requirement to scale up the investment in its equipment?
What are the reasons for a plateaued graph?
These could be some of the important questions companies can find answers to with the help of management accounting.
Analyze and Assess Productivity
The generated reports in the process are a fine measure of how the company and its various departments have been operating.
Through a detailed report of analytical techniques, it would be easy to point out the areas which need improvement. Aside from this, the reports are also capable of depicting the number of efforts that will be required to achieve the task.
Evaluate the Rate of Return
Estimating the ROR becomes specifically important in cases where the projects require a hefty volume of investment. It is, therefore, imperative to ask certain questions in this direction.
For example, will the outcomes be beneficial after investing in a project? When faced with multiple opportunities, opting for which one would be most profitable for the organization?
These are all the ways to find out the values of ROR much before the project starts. Management accounting answers these vital questions for the team working on such expensive projects.
Reckoning cash flows
Knowing where the cash will come from to carry out a hiccup-free business is undeniably an advantage. This helps the company decide the future flow of work and plan out the details in terms of expenditure.
With management accounting, the financial experts can work on budgets and present the statistics to the management to assist them to reach a decisive platform. Management accounting facilitates this innate knowledge to focus on growth trajectory.
Coordinate and Control
With the available holistic financial information, the management certainly finds it easy to coordinate between the different teams and levels within the organization. This gives it a lead to take control of diverse business operations.
This also forms as one of the primary objectives of management accounting. It involves preparing and planning goals and budget in a way that it tends to motivate the team. This can be achieved by deciding targets that are practically reachable and inspires the employees to put their best foot forward to accomplish them.
What are Some Management Accounting Deliverables?
So far, we have learned that management accounting helps recognize, measure, and communicate information that is helpful to managers to foresee and achieve goals through expert decision-making.
Management accounting also includes generating reports of budgeting, trend analysis, costing, forecasting sales on weekly, daily, or monthly performance. Let’s see the roles and principles fulfilled by management accounting.
Cost Accounting Report: Evaluation of costs of products and the various processes within the company’s framework is what cost accounting deals with. This report depicts profit margins, cost prices, and selling prices of the goods, cost of labor, or any other costs related to the article being manufactured. It also aids in preparing accurate statistical reports to arrive at goal-oriented decisions. It provides vital information regarding the storage of inventory and the costs associated with storing. It helps in optimizing resources and monitoring expenses comprehensively.
Account Receivable Aging Report: This is specific to and significant for a business that extends credits massively to its customers or clients. This kind of business needs to inspect a receivable aging report which presents a breakdown of balances. This in turn enables the managers to spot the debtors and strategize collection techniques.
This report also empowers the management to look up policies that are more robust and facilitate an uninterrupted cash flow, which is extremely crucial to an organization.
Overall Performance Report: Management accounting is also responsible for producing a holistic performance report. The companies evaluate the performance of each employee in every department. This report indicates the achievers and the under-performers within the company. It also showcases the possible glitches in the workflow of its operations. It sums up an aggregated performance to decide if the company is on the right path.
Other Significant Reports: Managerial accounting also releases reports on various other important facets. This includes project reports, order information reports, and analysis of competitors, among others.
What is in Management Accounts?
While budgeting and costing are considered as the primary reasons we have management accounts, there could be other reasons for having management accounting in place.
Every business is unique and organizations need to keep in mind the areas that need improvement within their own company. For this reason, it is important to keep the management accounts aligned with the requirements specific to the individual organizations.
To understand the concept better, let us see some examples. Here, we see what could be the possible inclusions while creating management accounts for your company.
Examples of Management Accounts
If yours is a startup that is growing but yet to experience its first major milestone, then you would probably need some of the basic parameters to go in your financial reports. It may look like this:
This is all you may need to get started with. After you have completed your first assessment and acquired a firmer ground in the business, you may decide to add a few more parameters that would lead to effective decision-making.
A Growing Startup But not Yet There:
This stage comes after there have been some developments in your startup. This time around, you may experience an increased need for funding or you may want to estimate your receivables or payables. You may also want to set or estimate the budget for future business operations.
Let’s consider this table.
In a consistently growing business, you may observe that you may constantly need to add parameters to keep a close tab on the way your business performs. Adding them as and when required down the line would be a great option rather than adding them in the beginning and feel baffled with so much information.
So, start with some of the most fundamental points and add more when required.
A Developed Business:
A business expanding at a fast pace needs many more components that need to be reported. Now, there are people associated with your business such as shareholders, investors, vendors. With so much happening around and with multiple factors affecting a developed business, you would undeniably require a detailed disintegration of the performance.
Here’s what you may want to report.
The more you learn about these key parameters and the more insights you have, the better would be the decision-making. This would eventually reflect on the revenue and profits of the organizations.
Having said that, if you find your business growing steadily even after its first few milestones, it might be time to revisit this table and trim down the unnecessary points. You may then want to focus only on the top 4 or 5 KPIs that would indicate a mega-development in the future.
All the above scenarios are indicative of the fact that you need to routinely assess management accounts to gauge your company’s stance; and also that management accounting is purely situation-driven.
What are the Types of Management Accounting?
Now that we are fairly familiar with the term, let’s learn about the various types of management accounting.
Product Costing and Valuation: The costing of a product involves determining the total cost of a good or service. Costs may be divided into various classes such as variable, fixed, direct, and indirect expenditure. In addition to the overhead for each type of product that the company creates, cost accounting is used to measure and identify those costs.
Managers, with meticulous calculation, assign overhead charges to assess the end-to-end cost of producing the goods. The overhead costs may take into account the number of goods produced or other production drivers such as the square foot of the facility.
Together with overhead costs, management accountants use direct costs to adequately value the cost of the goods sold in different stages of production and inventory.
Marginal costing, also referred to as Cost-Volume-Profit Analysis, denotes the impact of adding one further unit into production on the final cost of the product; which further impacts the long-term profit of the organization. This analysis immensely aids in taking short-term financial decisions.
Inventory Turnover Analysis: This provides an estimate of the number of times the company had sold or replaced a product in a given time frame. This is highly effective in taking decisions pertaining to pricing, marketing, manufacturing, and buying new inventory. At this stage, the management accountant may point out any issues associated with the holding cost of the inventory or costs incurred for the storage of unsold goods.
The inventory turnover analysis is an excellent way to judge if there is room for improvements concerning the inventory costs. If there is a big amount associated, the managers can work out plans to release and utilize this cash for other essential purposes.
Cash flow analysis: This is needed to analyze the cash impact of the decisions. The management accountants can opt for deploying strategies so that the company has enough liquidity for short-term obligations. In conducting a cash flow analysis, the management accountant considers the cash inflow or outflow that is generated by a specific business decision.
Financial Leverage Metrics: This term describes how efficiently the company uses its borrowed capital to acquire new assets. It also aims at improving the company’s return on investment.
Management accountants analyze balance sheets and utilize tools to make the best use of the leverage. Management can gain information about borrowed capital from the performance measures such as debt to equity, return on equity and return on the capital invested, before communicating these results to third parties.
Financial Leverage Metrics is exceptionally important for enabling the management to thoroughly review the statistics.
Constraint Analysis: This analysis is essential to identify any limitations or bottlenecks in the sales process. It is important for the management accountants to compute these constraints which affect the profit, revenue, and cash flow.
The accountants can then use this obtained information to fill the gaps and improve overall efficiency related to production and sales procedures.
Accounts Receivables Management: The AR management involves an accounts receivables aging report that sorts and classifies invoices based on the time duration they have been outstanding. This could prove to be beneficial to the company’s performance in the long run.
We can consider an example for clearer understanding.
The invoices are classified on their outstanding receivables in this format: less than 30 days, 30 to 60 days, 60 to 90 days, and over 90 days. The accountant needs to review and highlight the receivables to the respective department managers. They should also bring to the notice of the managers if certain customers are becoming credit risks.
Budgeting, Forecasting, and Trend Analysis: Budgets set the ground for the proposed actions. Performance reports present enough data for the accountants to note if there have been any overstepping of the set budget. These reports are also beneficial in jotting down the deviations and work toward achieving better results going forward.
Managerial accounting also checks the information from the previous periods for a precise future prediction. Information such as historical pricing, geographical locations, sales statuses, and customer inclination are important for adequate forecasting.
Reviewing trends is one of the important aspects of managerial accounting. This revolves around investigating expenses and unusual deviations. Careful and detailed scrutiny is essential to answer significant questions on unexpected variations, during external final audits.
What is a Management Accounting System?
Management Accounting System implements techniques involved in management accounting and works across all the departments in a company. From finance, sales, and operations to HR, IT, and marketing, an effective system will look into each of these.
Moreover, aside from the regular financial information, it also includes non-financial information. This could include cash on hand, delivery deadlines, updates on accounts payables and receivables, and product inventory status to name a few.
All this information is conducive to recognize the key performance indicators in various areas of the business.
Management Accounting Systems are principally aimed at monitoring costs related to manufacturing goods and services. Apart from traditional cost accounting, the management accounting systems also include throughput accounting, lean accounting, and transfer prices.
All these accounting systems aim at facilitating numerous methods of supervising the costs associated with producing goods and services. If a company does not employ any of the accounting systems, the risks of encountering over-priced goods or lower profits become higher.
How does Management Accounting Help Managers and Businesses?
Management accounting is necessary for businesses owing to its immense capability to change business performance and financial position. Managers can greatly benefit from the efficiently generated financial reports through management accounting.
Let’s see how managers can make the most of these reports.
Enhances Efficacy of the Organization: Without a doubt, a conclusive report makes it easier for the management to reach the desired goals and objectives. Reports with exhaustive information on the performance of the employees help reward the meritorious staff and motivate the ones who haven’t performed up to the mark. Bonuses and promotions are prominent ways to inspire the employees; which may propel productivity.
Fuels the Profit Engine: Capital budgeting and budgetary control are methods adopted in management accounting. These help the managers to identify mechanisms that curb unnecessary expenditure and divert cash flow for other pivotal business operations. Such measures significantly raise the bar of profits for the company.
Estimating future from past results: With reports that present data from the past as well as the current ongoings in a company, it becomes convenient for the managers to predict and foresee certain aspects beforehand. A well-informed manager can drive the enterprise towards the set aims and work with the information to generate profits.
Using Breakthrough Tools and Techniques: This is one of the major reasons the companies warmly embrace management accounting. These tools are not only reliable but are instrumental in creating authentic reports. It utilizes tools such as marginal costing, control costing, budget controlling. Although the use of these tools is based on the kind of issues a company faces, they certainly make it much more effortless for the managers.
With this, we have closely understood the importance of management accounting for the managers as well as the business.
Management Accounting vs Financial Accounting
Management accounting and financial accounting are sometimes used interchangeably but the two are different from each other in more ways than one. This section addresses these dissimilarities. Having learned about management accounting rigorously, let us first see the definition of financial accounting.
What is Financial Accounting?
Financial Accounting implements various accounting principles to provide consistent financial information to tax authorities, investors, creditors, and regulators. Most of the non-profits and small businesses adopt implement financial accounting.
Here, the financial statements classify the 5 major angles of financial data which are:
- Liabilities and
Financial accounting indicates the revenues, expenses, and net income on the income statement or Profitability Statement whereas assets, equity, and liabilities are presented on the balance sheet.
Characteristics of Financial Accounting
Before we compare the two types of accounting, here are the important features of financial accounting.
Considers only financial transactions: This type of accounting considers only financial or monetary transactions. All the non-financial transactions do not hold significance under financial accounting, even if they are otherwise important to the organization.
Legally a Must: Financial accounting is necessary and legally a must condition for companies. Preparing and auditing the financial statements derived from accounting is mandatory.
Historical in Nature: It is historical which means that it considers only the financial records of the past and does not have a futuristic view like management accounting.
External use: Unlike management accounting, this mechanism generates statements and reports for the people who are external to the company and not related to the decision-making process. It discloses the entire financial status for the people such as investors, suppliers, banks, and government.
Generates interim reports: The statement and reports produced after conducting financial accounting are only interim and not final.
Now that we have a fair idea of financial accounting, let’s move ahead to listing down its top 10 differences from management accounting.
- Management accounting includes the submission of financial information specifically for internal management purposes for making intelligent business decisions.
- Management accounting statement presentation can be modified to meet the situation’s or user's needs.
- It covers many aspects, such as product costing, budgeting, forecasting, and various financial analyzes.
- Unlike financial accounting, the techniques used in management accounting are not dictated by accounting standards.
- There are numerous differences between financial accounting and management accounting.
- Though it does not directly create decisions, management accounting closely affects the course of the informed decision-making process for a business.
With these facts, we wrap up this piece and hope to clear any lurking doubts related to management accounting.