Key differences between management vs. financial accounting
Management and financial accounting are part of the same accounting system and can be seen as two sides of the same coin. Both forms of accounting take the same underlying data to provide financial information to users. Each stakeholder in the business will find different aspects of the information provided by financial and management accountants useful. Nevertheless, the goal of both types of accounting is to help drive the business towards a better future.
What is financial and management accounting?
Financial and management accounting are two legs of accounting that provide the stakeholders of the business with a better financial picture of the organisation. It helps the managers in the decision-making process and helps them plan for the future.
Financial accounting is a niche area of accounting that lets the stakeholders know how the company is performing financially. These accountants prepare the financial reports of the business like the profit and loss, balance sheet and cash flow statements. It provides an overview and a summary of all the transactions that have occurred in the business over the course of the financial year. This information is valuable to managers as it helps them decide how to allocate the budgets for the quarter and it also helps investors assess if the company is worth investing in. There is a greater risk of human error and fraud in financial accounting which is why ethical principles and accounting standards such as GAAP and IFRS have become incredibly important in recent years.
Management accounting is also referred to as cost accounting or managerial accounting and provides a big picture of the company. It looks at events that happen in the business, both internally and externally and uses the data gathered from the findings to create estimates for the business. These estimates will eventually help in decision-making and anticipating the future needs of the business. Management accounting can include various facets such as capital budgets, trends, forecasts, valuations and product costing.
Key differences between financial and management accounting
Both financial and management accounting help stakeholders make more informed decisions about the business, however, there are a few key differences between the two types of accounting. These include:
1. The purpose
The main purpose of financial accounting is to disclose the numbers of business during the financial period. This includes preparing monthly financial statements that provide an overview of the company’s revenue and expenses. This information is provided to the external stakeholders of the business.
Management accounting helps the day to day managers of the firm. Managerial or cost accountants use the external and internal events in the company to provide information that will help the business set goals and plan for the future.
2. Regulatory requirements
In accordance with government regulations, it is mandatory for publicly listed companies to provide a copy of their financial statements to the governing board. This information is provided to ensure that the statements comply with ethical principles and are free from bias. These records also let investors know how the company is performing financially.
The information provided by management accountants is at the discretion of the managers and is used for internal decision-making. Information such as the cash available in the business, sales revenue and inventory is provided as part of management accounting. This data helps management make predictions about the future of the business hence the records are not made public.
3. Governing principles
In most countries, the financial statements need to be prepared in accordance with the Generally Accepted Accounting Principles (GAAP). This is a framework that provides the accounting standards, basic accounting principles and industry-specific rules that need to be followed when preparing the company’s financial statements. In India, the GAAP rules are established by the Institute of Chartered Accountants of India (ICAI). The rules help standardise the financial statements of various companies making it easier for investors to understand the information.
For management accounting, there are no specific rules or standards to follow when preparing the statements. The information provided by this leg of accounting only serves the internal management in their day to day activities and planning for the future. Hence, these statements are only prepared based on the needs and requirements of the management team.
4. Beneficiaries of the statements
Financial statements are mainly prepared for external use. The information provided helps provide a better picture of the business’ financial position like its profit and losses. There are numerous external stakeholders in the business and each one finds different areas or aspects of the financial statements useful.
Investors are the main users of a company’s financial records. The two main reports provided to the investors is the balance sheet which lists the company’s assets and liabilities and the profit and loss account that shows the income and expenses. Potential lenders will find the value of the company’s debt, that is, the current and long-term liabilities useful as it helps them judge if the company is creditworthy or overleveraged. They will also ensure that the company is generating enough revenue to cover its interest payments. Potential and existing shareholders will be more interested in the equity portion of the balance sheet which includes the retained earnings and earnings per share.
Management accounting statements, on the other hand, are used by internal parties such as the CEO, CFO and the directors. These reports show data at a more granular level and are more important in the day to day running of the business. The reports are also produced weekly and monthly so that internal stakeholders can take some key decisions based on the numbers.
5. Time period
Financial statements are usually produced once in each financial period. The main aim of the report is to look back at the past year to get a high-level understanding of the financial position of the company. The time horizon for financial statements is in the past.
Management accounting reports don’t have a specific time period during which they need to be prepared. Since they provide management with deeper insights on the current operations, they are produced as required. The information is used to make operational decisions and create forecasts and budgets. The time horizon for management accounting is focused on the future.
Very often companies use financial and management accounting in congruence with each other but the two forms of accounting are completely different. Financial accounting mainly deals with disclosure and providing shareholders with an idea of how the company is performing while management accounting informs the top management in the company about the health of the business and also highlights areas for improvement. Although they serve different purposes, both financial and management accounting is essential for all companies.