Fundamentals of Cost Accounting

Meaning and Definition of Management Accounting

Management Accounting Definition

Management accounting also is known as managerial accounting and can be defined as a process of providing financial information and resources to the managers in decision making. Management accounting is only used by the internal team of the organization, and this is the only thing which makes it different from financial accounting. In this process, financial information and reports such as invoice, financial balance statement is shared by finance administration with the management team of the company. Objective of management accounting is to use this statistical data and take a better and accurate decision, controlling the enterprise, business activities, and development.

Financial accounting is the recording and presentation of information for the benefit of the various stakeholders of an organization. Management accounting, on the other hand, is the presentation of financial data and business activities for the internal management of the organization. In this article, we will learn what is management accounting and its functions.

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Introduction to Management Accounting

One of the definitions of Management accounting says that it is the application of professional skills and knowledge in the preparation of financial and accounting information in a manner in which it will assist the internal management in the formulation of policies, planning, and control of the operations of the firm.

The basic function of management accounting is to help the management make decisions. There is no fixed structure or format for it.

Financial accounting, costing, business analysis, economics, etc are some tools and techniques of management accounting.

The only need for management accounting is that the data should serve its purpose, which is helping the management take important business decisions.

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How Managerial Accounting Works?

Managerial accounting involves many aspects of accounting. It aims at improving the quality of information about business operation metrics. Information relating to the cost and sales revenue of goods and services of the company is useful to the managerial accountants. Cost accounting is a large subset of managerial accounting. Cost Accounting focuses on ascertaining a company’s total costs of production by assessing the variable costs as well as fixed costs. It helps businesses in identifying and reducing unnecessary expenses and maximizing profits.

Types of Managerial Accounting

1. Product Costing and Valuation

Costs can be bifurcated into the variable, fixed, direct, or indirect costs. Cost accounting helps in measuring and identifying these costs as well as assigning overheads to each type of product or service. Product costing, thus, determines the total costs incurred in the production of a good or service.

Managerial accounting helps in calculating and allocating overhead charges to assess the expenses or costs related to the production of a good or service. The overhead expenses can be allocated on the basis of the number of goods produced, the number of hours run, the number of machine-hours, the square footage of the facility or any other activity drivers related to production. Managerial accounting also uses direct costs for the purpose of valuing the cost of goods sold and inventory.

2. Cash Flow Analysis

Cash flow analysis helps in determining the cash impact of business decisions. Most companies follow the accrual basis of accounting to record their financial information as it provides a more accurate picture of a company’s true financial position. However, it also makes it difficult to measure the true cash impact of a single financial transaction. By implementing working capital management strategies, one may optimize cash flow and ensure that the company has enough liquid assets to cover short-term obligations. While performing the cash flow analysis, one needs to consider the cash inflow or outflow generated as a result of a specific business decision.

3. Inventory Turnover Analysis

Inventory turnover involves a calculation of how many times the inventory has been sold and replaced in a given period of time. It helps businesses in making better decisions on pricing, manufacturing, marketing, and purchasing inventory. Inventory Turnover analysis also helps in identifying the carrying cost of inventory. The carrying cost of inventory is the amount of expense a company incurs to store unsold items.

4. Constraint Analysis

Reviewing the constraints within a production line or sales process is also a part of Managerial accounting. It involves determining where bottlenecks occur and calculating the impact of these constraints on revenue, profit, and cash flow. This information is useful to implement changes and improve efficiencies in the production or sales process.

5. Financial Leverage Metrics

Financial leverage refers to the use of borrowed funds in order to acquire assets and increase its return on investments. Through balance sheet analysis, the company’s debt and equity mix in order to put leverage to its most optimal use can be studied. Performance measures such as return on equity, debt to equity, and return on invested capital help the managers to identify key information about borrowed capital.

6. Accounts Receivable (AR) Management

Accounts Receivables invoices are categorized by the length of time they have been outstanding in an accounts receivable ageing report. It may list all outstanding receivables less than 30 days, 30 to 60 days, 60 to 90 days, and 90+ days. It helps the managers to ascertain whether certain customers are becoming credit risks. If a customer routinely pays late, management may reconsider doing any future business on credit with that customer.

7. Budgeting, Trend Analysis, and Forecasting

Budgets are a quantitative expression of the company’s plan of operation. Performance reports are used to study the deviations of actual results from budgets. The positive or negative deviations from a budget are analyzed in order to make appropriate changes going forward with the future planning.

Managerial accounting also helps in analyzing information related to capital expenditure decisions with the use of standard capital budgeting metrics, such as NPV and IRR. It assists decision-makers on whether to invest in capital-intensive projects or purchases or not.

Managerial accounting also includes reviewing the trendline for certain expenses as well as investigating unusual deviations.

Advantages and Objectives of Management Accounting

There are many objectives but the prime objective is to assist the management team of an organization in improving the quality of their decisions. The purpose of management accounting is to help the managerial team with financial information so that they can execute business operations and activities more efficiently. Following is the list of all benefits of management accounting –

  1. Decision Making
  2. Planning
  3. Controlling business operations
  4. Organizing
  5. Understanding financial data
  6. Identifying business problem areas
  7. Strategic Management

Decision Making

This is the most important benefit of the process of management accounting. In fact, it is the main purpose of it. In this form of accounting, we use techniques from all fields like costing, economics, statistics, etc.

It provides us with charts, tables, forecasts and various such analysis that makes the process of decision making easier and more justified.

Read Costing – An Aid to Management here in detail

Planning

Managerial accounting does not have any strict timelines like financial accounting. It is, in fact, a continuous and ongoing process.

So financial and other information is presented to the management at regular intervals like weekly, monthly or sometimes even daily.

Hence managers can use this analysis and data to plan the activities of the organization. For example, if the recent data shows a dip in the sales for a certain region, then the sales manager can advise his team and plan some action to rectify the situation.

Identifying Business Problem Areas

If some product is not performing well, or some department is running into unexpected losses, etc. managerial accounting can help us identify the underlying cause.

Actually, if the management is diligent and their data and reports are frequent, they can identify the problem very early on. This will allow the management to get ahead of the problem.

Strategic Management

Concept of management accounting is not mandatory by any law. So it can have its own structure according to the company’s requirements. So if the company feels certain areas need more in-depth analysis or investigation it can do so freely.

This allows them to focus on some core areas. The information presented to them allows them to make strategic management decisions.

Like if the company wishes to launch a new product line, or discontinue an existing one, management accounting will play a huge part in this strategy.

Limitations of Management Accounting

  • Data based on Financial accounting – Decisions taken by the management team are based on the data provided by Financial Accounting
  • Less knowledge – Management has insufficient knowledge of economics, finance, statistics, etc.
  • Outdated data – Management team receives historical data, which may change eventually when management is taking the decisions.
  • Expensive – Setting up a management accounting system requires a lot of investment.

Difference between Management Accounting and Financial Accounting

Sr. No. Management Accounting Financial Accounting
1 Only used for internal purposes of the firm For external reporting to various stakeholders and mandatory by law in most cases
2 Is not under the regulation of any law or regulations Is governed by Standards, Laws, regulations, etc
3 The main purpose is to help internal management take decisions Helps investors, creditors, etc. take investment decisions
4 Includes both financial and non-financial information Is only concerned with financial information
5 Not subject to any audits or investigation Financial records are audited as per the norms

Solved Questions for You

Q: Does management accounting help in financial accounting?

Ans; Yes it does. Management accounting occurs at regular intervals. So it helps provide some framework for the financial accounting that only occurs at year-end. Nowadays all accounting systems are automated, so the recorded and verified data does help financial accounting.

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