Through this article, you will learn about the definition, types and difference between financial and management accounting.
Table of Contents
- What is financial accounting?
- Types of financial accounting
- What is managerial accounting?
- Types of managerial accounting
- Difference between financial accounting and management accounting
Accounting has three main types including cost accounting, financial accounting and management accounting. All three types serve different purposes and functions. In this article, we will discuss the difference between financial accounting and management accounting.
What is Financial Accounting?
Financial accounting is one of the branches of accounting. It involves the process of recording, summarising and reporting business transactions over a period of time. These business transactions are summarised in financial statements. This branch of accounting involves the use of globally accepted accounting principles.
These are Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Here financial statements represent five classifications of the data: revenue, assets, liabilities, expenses and equity. Asset, liability and equity are reported in the balance sheet which uses the financial data for future economic benefits. Expenses and revenue are reported on the income statement.
Types of Financial Accounting
There are two main methods of performing financial accounting: the accrual and cash methods. In some cases, the combination of the two methods is also utilised for financial accounting.
1. Accrual Method
Through the accrual method, companies record the revenue before receiving the payment for their products. Revenue is recorded in the accounting books of the company before the actual cash transaction takes place. This accounting method is based on the matching principle which says that expenses and revenues must be recognized in the same period.
Accrual accounting reflects the financial performance of a company during a time period. They can correlate expenses and sales during the same accounting period. Through this method, businesses can identify their profitability.
2. Cash Method
Cash accounting is a method where payment receipts are recorded when they are actually received. Similarly, expenses are recorded when they are actually paid. Small-scale businesses use this accounting since it is more straightforward and simple.
However, if an organisation is following GAAP, then it must opt for an accrual accounting method. Cash accounting is less accurate since they affect the company’s books with delay when the transaction actually takes place.
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What is Management Accounting?
It is a branch of accounting in which professionals create financial statements, documents and reports for management. Through these resources, management is better equipped to make wise business performance-related decisions. Functions of management accounting include forecasting and planning, organizing, coordinating, performance variances, etc. Managerial accounting has the following functions:
- Source of data: The historical data recorded through management accounting can offer insights to forecast future trends in business.
- Making decisions: It offers insight into the cost and production availability, which are the deciding factors in the purchase choice.
- Forecasting cash flows: Through these accounting methods, management can create budgets and trend charts for fund and resource allocation to generate the projected revenue.
- Rate of returns: Management accounting helps in identifying the investment with a better rate of returns. This allows wiser investment decisions before getting into a project.
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Types of Management Accounting
There are seven main types of managerial accounting:
1. Cash Flow Analysis
Managerial accountants perform cash flow analysis to identify the impact of cash on business decisions. Implementation of working capital management strategies helps in optimising the cash flow. It also ensures that the company has sufficient liquid assets to cover short-term obligations. In comparison with accrual accounting, cash flow analysis helps in understanding the cash impact of a single financial transaction.
2. Inventory Turnover Analysis
This indicates the frequency of selling and replacing inventory in a given period of time. Managerial accountants can identify the carrying cost of inventory which helps in understanding the expenses incurred for storing an unsold item. If there is excess inventory, they could make changes to reduce storage costs and free the cash flow for more productive operations. Through inventory turnover, businesses can make wiser decisions on the manufacturing, pricing, marketing and purchasing of inventory.
3. Product Costing
It helps in determining the total cost for producing a good or service. It includes fixed, variable, direct and indirect costs. To identify these costs, cost accounting is used. Companies assign overhead to every product that it creates. Accountants calculate and then allocate the overhead charges to assess the total expenses incurred in the production. This may be based on the number of products or production activities. Direct costs help in the accurate valuation of the cost of inventory and goods sold.
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4. Accounts Receivable (AR) Management
Receivable denotes the payment that is yet to be received. This happens when the company extends a credit facility to its customers. This, in turn, gives rise to the accounts receivable (AR) in financial statements. If AR is appropriately managed, then it can have a positive impact on the company’s bottom line. Through the management of AR, businesses can identify customers who have become credit risk and may reconsider the decision to extend a credit line to that customer.
5. Financial Leverage Metrics
It refers to the use of borrowed capital for acquiring assets and increasing the ROI. Through the analysis of the balance sheet, managerial accountants can choose tools to study a company’s debt and equity to optimise leverage. Management can identify information on borrowed capital using performance measures instead of outside sources.
Accountants can use performance reports to understand the deviations from actual results with the help of a budget. The budget-to-actual variance which indicates positive or negative deviations from budgets to make required changes for the future.
7. Constraint Analysis
This is also a part of management accounting where constraints are reviewed within the sales process and production line. They can identify the areas where there may be any bottlenecks. They can calculate the impacts of constraints on profit, cash flow and revenue. This information is used for improving processes to increase efficiency in the sales process.
Difference Between Financial Accounting and Management Accounting
As we have taken a detailed look at financial and management accounting, let us now learn the difference between the two.
|Parameter||Financial Accounting||Managerial Accounting|
|Adherence||Must follow guidelines of either GAAP or IFRS, whichever is applicable.||No requirement to follow rules since it is used for internal purposes in the organisation.|
|Nature of statements||General-purpose statements||Special purpose statements|
|Publishing and Auditing status||Required||Not Required|
|Format||Specific to allow comparison||Informal|
|Reporting||Defined timeline||Not defined, as per the requirement|
|Disclosure status||For public intent||Confidential|
Both accounting branches provide financial information but they serve different purposes. You cannot identify the importance of one branch over another and it is not necessary. We hope this article has been able to help you understand the difference between the two.
Name the external users of accounting information.
Shareholders, customers, suppliers, banks, government and investors are the external users of accounting information.
Can anyone go through management accounting reports?
No, these reports are meant for internal use only. No outsider can access these reports.
How is cost accounting different from financial and management accounting?
Cost accounting involves a larger set of reports which is exclusively for internal purposes. These reports assess input cost at each step of production.
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