When most people think of accounting, they think of a complex web of rules and processes that must be followed, lest the IRS uncover any mistakes. While there are rules that must be followed and taxes that must be filed, “accounting” as an umbrella term can mean a few different things.
On one hand, it means managing your finances in a way that follows the Generally Accepted Accounting Principles, or GAAP, and is presentable to any outside parties that might want to take a look at your books. This might include banks, investors, shareholders, and, yes, the IRS. This is commonly referred to as “financial accounting.”
On the other hand, we have “managerial accounting.” Unlike financial accounting, this kind of accounting is not meant to be shared with anyone outside the company. Instead, it’s used to, well, manage things. Leadership will use the reports and data from managerial accounting to track how the business is doing and to make decisions.
These two ways of accounting are not necessarily contradictory. They still follow the same basic rules. However, there are a few key differences.
Managerial vs. Financial Accounting
The starkest difference between these two is the intended audience. Managerial accounting is done solely for an internal audience. The numbers and reports generated are not meant to be shown to anyone outside the organization. They’re purely for decision-making purposes.
Financial accounting traditionally has an external audience. In other words, financial statements and reports are generated for people outside of the organization (usually people with a very official purpose for them). Here at ScaleFactor, we like to make the argument that your financial statements, developed using financial accounting and its many rules, are the best historical record businesses have of how they’ve done. As such, they’re pretty valuable to business owners, too.
Nevertheless, the intended audience is the primary point of difference between the two and is the reason behind the other key differences, including the standard for accuracy used and timing.
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Managerial Accounting Has Fewer Rules
Because managerial accounting is intended only for an internal audience of managers and decision-makers, the rules are less strict. Where financial accounting yields a specific set of financial reports—the income statement, balance sheet, and usually a cash flow statement—managerial accounting can produce a wide range of performance reports and metrics.
The main reason that financial accounting has so many rules is that it allows all companies to be evaluated by the same basic criteria. If the intended audience is banks, investors, and the IRS, it makes sense that they need every business to follow the same basic processes. If not, how could they evaluate whether to invest? How could they double check your tax obligations? If every business plays by the same basic rules, these external users can look at an income statement or balance sheet and get the financial information they need. Not only that—they can trust that those numbers are accurate.
Anything to do with a company’s finances is valuable information, and it’s important that it’s right. The stakes are simply higher when people outside the company are taking a look at the books, so bending the rules of accounting slightly is occasionally forgiven under managerial accounting.
Managerial Accounting Looks to the Future, Financial Accounting to the Past
Financial reports are generated at the end of an accounting period, which could be a month, a quarter, or a year. Their creation is part of the accounting close process, where all loose ends from that period are tied up. In other words, every transaction has been accounted for and classified correctly, and there are no outstanding questions about what took place during that time.
As a result, these statements are purely a reflection of what happened during that period. They don’t do any forecasting or hypothesizing about the future. They are, instead, an incredibly accurate historical record of a very specific time in your business’ life.
Managerial accounting looks at what happened in the past, but it also helps businesses think critically about the future. Forecasting and budgeting, for example, are functions of managerial accounting. In order to make a forecast, you need historical data. But the value of a forecast lies in what it shows you about the future—in the ability to plan ahead.
Managerial Accounting Lets You Narrow In On Departments
While there are certainly ways to slice and dice the data you get from financial accounting, managerial accounting let’s you get more granular. You can break out data and projections on a department-level basis, analyzing how the marketing team did against their specific goals, for example.
Financial accounting is intended to provide a more macro view of your business, again because of the intended audience. A lender may not care how each team is doing. They care most about the bottom line of the company as a whole. But if leaders are going to use financial data to make decisions—to manage—they need to be able toe in on their areas of expertise.
Types of Managerial Accounting
Let’s look next at a few examples of managerial accounting in action and how businesses might use managerial accounting to help them through the decision-making process.
Budgets are incredibly useful tools for businesses. (Don’t have one? Check out this blog post about how to get started.) But at the end of the day, they are still projections about how you think your business will do. They’re not set in stone.
It’s important to keep an eye on how your actual results are stacking up against the budget. Are you on track or are you missing the mark? This kind of analysis is often done through a budget-to-actual comparison, and it can help business leaders decide if they need to refocus their efforts in order to meet their budgeted goals or if they need to rethink and reset those goals.
Nope, forecasting and budgeting are not the same thing, but they’re closely related. While budgeting spends a little more time looking at what happened in the past and using that historical information to set goals, forecasting responds real-time information to better predict what will happen in the future.
So if your actuals are far surpassing your budget, forecasting allows you to take that information and set new goals. It’s a building block on top of budgeting that helps you respond to changes and new information.
Capital Budgeting Analysis
Capital budgeting is a way of deciding whether or not to make a large purchase. It helps businesses understand all the costs associated with that purchase, as well as the probably profits it will generate.
Like budgeting, it relies on a mixture of historical knowledge, present-day costing, and forward-thinking projections.
Accounts Receivable Reports
An accounts receivable aging reports is a great example of managerial accounting at work. It looks at all outstanding accounts receivable, or money that you expect to come in to the business, and categorizes them based on how long they’ve been outstanding.
This report can help several teams within the organization. For example, if it’s taking longer than in the past to collect on payments, it might signal to the sales team that the customers they’re selling to aren’t the best fit.
Another similar metrics businesses can keep an eye on is days sales outstanding, or DSO, which tells businesses how long it takes them to collect on average.
Try out ScaleFactor’s own Days Sales Outstanding Calculator.
Cash Flow Analysis
Under accrual accounting, knowing where your cash is at any given time can be confusing. Cash flow is broadly defined as all the inflows and outflows of cash within your business. While a cash flow statement can be a very helpful report, generated using financial accounting, it can be created on a monthly frequency at a maximum.
So if you need real-time information about your cash, that’s where managerial accounting comes in. It can use all the transaction data you have, as well as accounts receivable and accounts payable data, to help map out your cash flow. This might help your accounts payable team, for example, decide when the best day to pay vendors will be.
Not having a firm grasp on cash flow is one of the riskiest things a business can do, but some simple managerial accounting practices can help alleviate those risks.
Who Needs Managerial Accounting?
The short answer: everyone. There are many more types of managerial accounting than we discussed here and many more forms of analysis your business can perform. You don’t need to do all of them to do managerial accounting.
If you’re creating a budget and comparing actual spending to it, you’re doing managerial accounting. If you’re looking at your cash flow regularly, you’re doing managerial accounting.
Just remember—the primary goal of managerial accounting is to help businesses make management decisions. So find the reports and metrics that help you drive your business forward and don’t feel like you need to do it all.
In fact, some facets of managerial accounting are incredibly complex. (Capital budgeting isn’t for the faint of heart.) The more complicated your business finances become over time, the more you might consider a managerial accountant or CFO to help you create financial models and interpret the findings.
ScaleFactor’s intuitive financial reporting can also help you make informed business decisions. Learn more about our customizable dashboard, real-time insights, and financial reports today.
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