The phrases, financial management, accounting, management accounting, can create a lot of confusion. A substantial portion of the population finds accounting a very dry, boring subject, one that only concerns itself with unexciting topics related to facts and figures.
Whether you are a student of accounting, or someone planning to run a business or become a key player in management, it is important to understand the difference between financial accounting and management accounting.
Management Accounting Definition
The provision of financial data and advice to a company for use in the organization and development of its business.
The Corporate Finance Institute sheds light on what management accounting entails. It usually involves the process of analysing and presenting data to managers involved in decision-making.
Let us take an example to understand this better. Consider an Indian company aiming to expand its operations globally. Among the many factors impacting this decision, one of the most important is the financial implications of migrating from local to global. The impact on the company’s operating costs and even their net revenue generation are of primary importance.
In this case, it is not the management accountant who leads most of the decision-making, rather it is the financial accountant. The former will be more concerned with identifying the problems and solutions from a business perspective, and strategies for the same.
Let us consider another example. Suppose an auto manufacturer needs to estimate the cost of retooling their production line for the latest proposed model. This would require the floor managers, who are much more knowledgeable of what exactly needs to be altered for the new production to roll out. Here, the management accountants project the estimated figures, and present their recommendations, based on which managers and executives arrive at a decision. Their role will be to deliberate, discuss and approve or reject the findings.
Objective management accounting requires the use of statistical data to ensure decisions are as accurate as can be. It is what drives an enterprise and forms the backbone of business activities and development. Businesses have the advantage of choosing between in-house accountants with managerial skills or outsourcing management accounting to independent accounting firms.
In our example, the company that wants to scale globally, will, in all likelihood seek out an external auditor. While on the other hand, due to the proprietary nature of manufacturing, the business will probably have management accountants on its company payroll.
The critical factor that distinguishes a management accountant from a public accountant is the secrecy of the data they compile, and that it stays in-house.
This means that the company's data compilation and analysis will not be published in financial statements, or be released to creditors, investors or tax authorities.
Objectives of Management Accounting
Management accountants are key to a business. They perform many roles related to company finances, business growth and expansion, and innovation and scale. Among the primary duties performed by a management consultant, here are the top one:
Decision-making, based on financial forecasts and data analysis. This is the most important benefit and the main purpose of management accounting.
Risk analysis and mitigation strategies. This helps a company prepare in advance for any adversities that may arise in the future.
In-depth market research to identify trends and opportunities. This can open up doors for innovation, outreach, and scale.
Maintain all company finance-related data to help in drafting the financial report at the end of the year for purposes of financial accounting.
Ensure and monitor budget compliance with all verticals in a company. This goes hand in hand with financial accounting.
The Chartered Institute of Management Accountants is a global institution that offers courses that are at par with industry standards and requirements in India.
What is Financial Accounting?
Financial accounting is the field of accounting concerned with the summary, analysis, and reporting of financial transactions related to a business, that involves the preparation of financial statements available for public use.
Financial accountants keep track of every single company transaction. The reports prepared by a financial accountant is not only used for internal tracking and strategic planning, but also presented to external stakeholders like investors, shareholders and the government, specifically the Income Tax Department. They also report, or at least make their books available to business/government regulators.
It is noteworthy to mention here that the same principles of accounting apply to both management and financial consulting. However, due to the non-confidential nature of financial accounting, the standards followed are significantly different. The Generally Accepted Accounting Principles in India apply to financial accounting practices.
In the case of a transnational or multinational corporation, they must further conform to the International Financial Reporting Standards should they trade on the global stage.
Objectives of Financial Accounting
Financial accountants mainly concern themselves with anything that comes under the purview of company finances, ranging from expense tracking to statutory compliances. Here are top responsibilities for a financial accountant:
- A big part of financial accounting entails ensuring compliance in line with the Companies Act, and taxation laws.
- Financial accounting standards are responsible for ensuring protection of investors' interests, by making financial information public.
- The transparent process of financial accounting facilitates cost and management accounting.
- Financial accounting plays a key role in providing reliable and relevant data related to company profit and loss, assets, liquidity and the like.
Financial accounting in a company covers transactions related to several types of expenses that can be categorised under the following heads:
Assets or company-owned property that impacts the valuation of the business.
Liabilities or materials that cost the company.
Expenditures are simply expenses incurred.
Equity or undisbursed interest to shareholders.
Revenues or the sum of all the income made by the company.
Financial accounting thus follows a four-step objective cycle that can be described in the following manner:
- Identify relevant financial data that need recording. This is important in filtering out data that is either non-financial or irrelevant for a particular reporting purpose.
- Categorize transactions of similar nature or with the same characteristics. This involves analysing and interpreting a transaction and entering the correct data in the books.
- Summarise transactions once they have been interpreted and grouped together. This is done keeping the end-user of the data in mind to ease reading of the data and increase comprehensibility.
- Respond to queries that may arise from the reporting. Questions around the use of resources pertaining to a particular transaction or a specific date, are common in financial audits. Financial accountants play the important role of responding transparently and with the accurate data.
Types of Financial Accounting
There are basically two different types of financial accounting when it comes to compiling a company's financial transactions:
- Cash Accounting: This type accounts for all cash transactions made by a company's employees. An example would be the out-of-pocket expenses incurred by a field executive. Usually, such transactions are logged on submission of receipts received against the cash transactions.
- Accrual Accounting: This can be looked at as an expanded form of cash accounting encompassing all kinds of transactions made, including through cash, credit, or other forms of payment.This type of financial accounting gives a big picture view of a company's flow of revenue and reflects if it has current assets or liabilities.
Learn more about the role of financial accountants in a business.
Underlining the Difference Between Management Accounting and Financial Accounting
Financial accounting is mandated by law, whereas management accounting is a business requirement. This is the biggest difference between the two concepts.
Management accounting is used for internal purposes, to plan and strategies, and to scale and innovate. Financial accounting, on the other hand is a mandatory reporting process that needs to be furnished to the public and important stakeholders.
Unlike financial accounting, management accounting is not regulated by any laws or statutes. Financial accounting is governed by the Companies Act and needs to adhere to local taxation laws, failing which might entail the blacklisting of the said company. The latter is also subject to audits, mostly by external entities to ensure unbiasedness and accuracy.
Management accounting helps executives arrive at decisions, while financial accounting helps investors and shareholders decide the course of business. Moreover, management accounting includes information related to company finances and other non-financial data. Find out how a managerial accountant differs from a financial accountant.
Management accounting also helps in financial accounting to an extent. Since it is a continuous process that takes place throughout the year, the data gathered and analysed by management accounting helps inform the final financial accounting report. Automation of such data also makes it easy to access these data at any time for reference.