Management Accounting

• Management accounting leverages company financial data for the strategic decision-making of its leadership.
• This method of accounting is at work in budget setting, forecasting, setting key performance indicators, and managing team goals.
• Managerial accounting includes margin analysis and constraint analysis for the long-term planning of a company.
• This article is for small business owners and managers who want to improve their financial literacy and accounting practices.

Financial accounting and management accounting differ significantly in the analysis and reports used, as well as the insights each offers. While they vary in the complexity of setup, most companies need to use both financial and managerial accounting, if only on a limited basis. Otherwise, company managers are forced to make considerably less informed decisions.

Management accounting is the process of analyzing information about a company's finances, interpreting it and using it to make decisions about the business. This process happens at multiple levels of an organization, but it generally involves managers of various teams and departments creating budgets, forecasts and schedules, then presenting to senior management for decision-making. Using financial accounting, managers can get insights into a company's past or current finances, but it's managerial accounting that allows them to translate this insight into actionable analysis.

This guide explains the differences between each type of accounting, as well as how businesses can use both to complement one another.

[Related Read: Accounting Software Benefits, Features, and Costs]

What is management accounting?

Management accounting is when a business's managers identify, analyze, and interpret key information about the company's finances and present that information to senior managers. This information plays a critical role in business decisions based on the company's financial circumstances, forecasts and trends.

Managerial accounting is similar to financial accounting in that financial accounting also involves preparing statements and reports. However, the analysis and reports in management accounting statements are based on the statements and reports prepared in financial accounting and used to draw conclusions about a specific business and the direction it should take.

Like financial accounting, management accounting is often aided with the use of accounting software. Just as most small business accounting software makes it easy to generate financial accounting reports, software can also make it easy to generate custom reports and forecasts based on this data.

Tip: Need a glossary for all the accounting lingo in this article? Read our definitions of accounting terms to clear things up!

What is the importance of management accounting?

Management accounting is extremely important for businesses because it allows them to translate hard data about their finances into reports that can be analyzed and used for strategic business decisions. After all, financial accounting doesn't mean anything if you don't apply the insights to your plans and decisions for your business.

These are some of the important business decisions that involve management accounting:

• Budgeting expenses
• Forecasting sales and variable expenses
• Setting goals for the business, individual teams and departments, and even specific employees
• Tracking key performance indicators (KPIs) to measure progress
• Determining value for buying or selling a business or specific assets

[Related: Guide to the Various Types of Accounting]

What are the challenges of management accounting?

While management accounting can help businesses in many ways, it still presents challenges. For one thing, you have to generate reports for the method to be helpful (though most accounting software makes this relatively easy). Also, while managerial accounting makes it easier to consolidate data into usable analysis, it doesn't make decisions for you. You (or your business's middle managers) have to call on your years of experience and knowledge to interpret the information and make the best decisions for your business. While management accounting can bring clarity to simple yes-no decisions (such as whether to buy an asset or sell a division), it isn't as helpful for selecting among multiple choices.

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Lastly, decisions that you or your managers make after reviewing accounting reports need to be based on not only executive insight, but also your business's risk tolerance, industry norms, where the company is in the growth cycle, and your specific growth objectives. There are no hard-and-fast rules for making decisions based on firm accounting.

Key takeaway: Management accounting relies on data, but its success starts and ends with human decision-making based on experience and intuition.

What are the functions of management accounting?

There are many uses for management accounting. Most companies don't use all of them, but the relevant use cases vary by organization, often depending on a company's size, the industry, and even the practices and preferences of individual managers.

Here are some of the functions management accounting serves:

• Determining cost of inventory or a job
• Calculating the break-even point
• Determining the business's bottlenecks and limitations (constraints)
• Optimizing costs of products or jobs
• Analyzing trends in revenue and expenses
• Setting company and department budgets
• Analyzing transaction costs and efficiency
• Setting prices and sales targets or quotas

Some companies may use management accounting to do all of these things, but most businesses only use some of these functions based on their needs. Management accounting is designed to help managers make decisions, so individual practices vary widely based on the specific needs of managers in a particular team, department, or company.

What are the types of managerial accounting?

You can set up most of these analyses fairly easily with business accounting software, which often presets the accounting formulas you'll need. Most companies don't need them all – especially businesses that are particularly small, flat or narrow in scope – but all small businesses can benefit from at least some of the functions named above.

[Related Content: How and Why to Create a Profit and Loss (P&L) Statement]

What is the difference between management and financial accounting?       

Financial accounting is the practice of tracking a company's financial transactions and building statements that summarize that company's financial activities and circumstances. Most small businesses use this method to track their transactions and organize records into consolidated statements summarizing their financial circumstances.

With financial accounting, businesses can measure their revenue and expenses, calculate their total company value, and track their cash flow. These activities can assist in tax planning and decision-making, but they're generally less sophisticated than managerial accounting analysis and much easier to do – most forms are easy to compile with basic business accounting software. Managerial accounting, meanwhile, involves using these statements for more in-depth analysis to plan, direct and control business operations.

In other words, management accounting involves more specialized analysis than financial accounting and is used more sparingly. Business owners and managers use it when they need to make important business decisions, such as whether to invest in various assets, buy or sell a business, start a new operation, or spin off a new line of products. This type of accounting may also require more work to set up forms for analysis with off-the-shelf accounting software, but it's still fairly easy to do.