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What is management accounting?
Management accounting is the practice of identifying, measuring, analyzing, interpreting, and communicating financial information to managers to achieve organizational goals.
Management accounting differs from financial accounting in that the intended purpose of management accounting is to help users within a company make informed business decisions.
focus
- Management accounting involves the presentation of financial information for internal purposes, for use by management in making key business decisions.
- Unlike financial accounting, the techniques used by management accountants are not regulated by accounting standards.
- The presentation of management accounting information can be modified to meet the specific needs of end users.
- Management accounting covers many aspects of accounting, including product cost accounting, budgeting, forecasting, and various financial analyses.
- This differs from financial accounting, which produces and publishes official financial statements that comply with current accounting standards for public consumption.
How management accounting works
Management accounting aims to improve the quality of information provided to management regarding business operating metrics. Management accountants use information related to the costs and sales revenue of goods and services generated by the company. Cost accounting is an important subset of management accounting that specializes in capturing a company’s total production costs by evaluating the variable costs as well as the fixed costs of each step of production. It enables businesses to identify and reduce unnecessary expenses and maximize profits.
The pillars of management accounting are planning, decision-making and control. Additionally, forecasting and performance tracking are key components. Through this focus, management accountants provide information designed to assist companies and departments in these key areas.
Management Accounting and Financial Accounting
The main difference between managerial accounting and financial accounting relates to the intended users of the information. Management accounting information aims to help managers within an organization make informed business decisions, while financial accounting aims to provide financial information to parties outside the organization.
Financial accounting must conform to certain standards, such as Generally Accepted Accounting Principles (GAAP). All public companies are required to prepare financial statements in accordance with generally accepted accounting principles as a requirement to maintain their publicly traded status. Most other companies in the United States adhere to GAAP to meet debt covenants typically required by financial institutions extending lines of credit.
Since management accounting is not suitable for external users, it can be modified to meet the needs of its intended users. This can vary greatly by company and even by department within a company. For example, a manager in a production department might want to see his financial information displayed as a percentage of units produced during the period. An HR manager may be interested in viewing a graph of employee salary over time. Management accounting is able to meet the needs of both departments by providing information in whatever format is most beneficial to the specific needs.
notes
Management accounting is not required to follow GAAP standards because it is used for internal purposes and not for external reporting.
Types of management accounting
Product costing and valuation
Product costing involves determining the total costs involved in the production of goods or services. Costs can be broken down into subcategories such as variable costs, fixed costs, direct costs, or indirect costs. In addition to allocating overhead costs to each product type a company creates, cost accounting is used to measure and identify these costs.
Management accountants calculate and allocate overhead costs to evaluate the total costs associated with the production of goods. Overhead expenses can be allocated based on the number of goods produced or other activity drivers related to production, such as the square footage of the facility. In conjunction with overhead expenses, management accountants use direct costs to properly assess the cost of goods sold and inventory that may be in various stages of production.
Marginal costing (sometimes called cost-volume-profit analysis) refers to the impact on the cost of a product of adding one extra unit to production. It is useful for short-term economic decisions. The contribution margin of a specific product refers to its impact on the company’s overall profits. Profit analysis moves into break-even analysis, which involves calculating the contribution margin of the sales mix to determine the number of units at which the business’s total sales equal total expenses. Breakeven point analysis is useful for determining the price point of products and services.
cash flow analysis
Management accountants conduct cash flow analysis to determine the impact of business decisions on cash. Most companies record their financial information according to accrual accounting. While accrual accounting can more accurately reflect a company’s true financial position, it also makes it more difficult to understand the true cash impact of individual financial transactions. Management accountants can implement working capital management strategies to optimize cash flow and ensure that the company has sufficient liquid assets to cover short-term obligations.
When a management accountant performs a cash flow analysis, he considers cash inflows or outflows that result from specific business decisions. For example, if a department manager is considering purchasing a company vehicle, he may choose to purchase the vehicle outright or obtain a loan. Management accountants may run different scenarios by department managers describing the cash outlay required for an outright upfront purchase versus a loan at a different interest rate over time.
Inventory turnover analysis
Inventory turnover is a calculation of how many times a company sells and replaces inventory in a given period of time. Calculating inventory turns can help businesses make better decisions about pricing, manufacturing, marketing, and purchasing new inventory. A management accountant can determine the carrying cost of inventory, which is the amount of expense a company incurs in storing unsold items.
If a company has excess inventory, it can improve efficiencies to reduce storage costs and free up cash flow for other business purposes.
constraint analysis
Management accounting also involves reviewing constraints in a production line or sales process. Management accountants help identify where bottlenecks occur and calculate the impact of these constraints on revenue, profits, and cash flow. Managers can then use this information to implement changes and make production or sales processes more efficient.
financial leverage indicator
Financial leverage is when a company uses borrowed funds to acquire assets and increase returns on investment. Through balance sheet analysis, management accountants can provide management with the tools they need to study a company’s debt and equity portfolio in order to make the most effective use of leverage.
Performance indicators such as return on equity, debt to equity and return on invested capital help management identify key information about borrowed capital before forwarding these statistics to external sources. It is important for management to review ratios and statistics regularly so that questions from the board, investors and creditors can be answered correctly.
Accounts Receivable (AR) Management
Properly managing accounts receivable (AR) can have a positive impact on a company’s bottom line. The accounts receivable aging report categorizes accounts receivable invoices by the length of time they have been outstanding. For example, an accounts receivable aging report might list all open accounts receivable that are less than 30 days old, 30 to 60 days old, 60 to 90 days old, and more than 90 days old.
By reviewing outstanding accounts receivable, management accountants can indicate to the appropriate department managers whether certain customers are facing credit risk. If a customer frequently makes late payments, management may reconsider any future credit business with that customer.
Budgeting, Trend Analysis and Forecasting
Budgets are widely used as a quantitative expression of a company’s operating plan. Management accountants use performance reports to document deviations of actual results from budgets. Analyze positive or negative deviations from the budget (also known as budget-to-actual variance) so that appropriate changes can be made in the future.
Management accountants analyze and communicate information relevant to capital expenditure decisions. This includes using standard capital budgeting metrics such as net present value and internal rate of return to assist decision-makers in deciding whether to pursue capital-intensive projects or purchases. Management accounting involves reviewing proposals, deciding whether a product or service is needed, and finding appropriate ways to finance purchases. It also outlines the payback period so management can predict future economic benefits.
Management accounting also involves reviewing trend lines for certain expenses and investigating unusual differences or deviations. It is important to review this information regularly, as expenses that differ significantly from what is normally expected are often questioned during external financial audits. This field of accounting also uses prior period information to calculate and predict future financial information. This may include using historical pricing, sales, geography, customer trends or financial information.
Are financial accounting and management accounting the same?
Although they often perform similar tasks, financial accounting is the process of preparing and presenting official quarterly or annual financial information for external use. Such reports may include audited financial statements that help investors and analysts decide whether to buy or sell company stock.
In contrast, management accounting uses formal indicators to describe and measure financial information tracked internally by business managers.
Do management accountants need to follow GAAP?
No, management accountants have no legal obligation to follow GAAP because the documents they produce are not governed by GAAP. These documents focus on internal company metrics of company performance.
What types of information does management accounting calculate?
Management accounting is useful for companies for tasks such as tracking and budgeting expenses, reducing costs, forecasting sales figures, and managing cash flow.
bottom line
Management accounting is important for drafting accurate and complete financial statements for internal use and formulating the company’s long-term strategy. Without good management accounting, company leadership may struggle to make appropriate choices or misunderstand the company’s true financial position. Because management accounting documents are not official, they do not have to comply with GAAP and may be used internally for a variety of purposes.
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