The core business of every business, whether it is a sole owner or a big
international company, is to do business or in lay-person''s
terms, make money. This means that it is not only the business or company that must be managed, but also the finances. If the finances are not managed properly or accounted for, the business or company can close shop. Even if you are making money like nobody’s business but your accounting system is not in place or not managed properly, you have lost the case.
It is at this stage clear that accounting is of the utmost importance. But there is
financial accounting and there is
management accounting. The purpose of this article is to explain the difference between the two concepts but also the similarities.
The purpose of
financial accounting is to provide information on the financial well being to external
stakeholders. External stakeholders can be shareholders, mortgage holders, finance houses, banks, sleeping partners, etc. It is therefore parties who were involved in the financing of such a business and therefore have a vested interest in the financial well-being of the business – would the business be able to meet all its commitments?
Financial accounting is therefore there to assist such parties to appreciate the financial value inherent in the business. The purpose of
management accounting is to provide information on the financial well-being of a business to internal stakeholders. Internal stakeholders are the management of the business and such information would assist them in the day-to-day running of the business. The need for such information is for instance to decide when to increase prices, is it possible to give salary increases, should staff be laid off, etc.
Financial accounting has to follow very strict guidelines and protocol in its compilation and final presentation form. These norms and guideline are actually internationally accepted and implemented. On the other hand, management accounting may be presented in any way that would suit management of a specific business. The only thing that counts is that it should assist them to make informed decisions which will always impact on a business.
Businesses and companies need the same type of financial information but the way in which it is compiled and presented will differ from business and company to another. To understand the difference (but also similarity) between the two concepts, the following needs to be understand:
Financial accounts focus on reporting past operations for a period already lapsed (normally one year called a financial year) while management accounts focus on the present and provide information managers can utilize to make informed projections for the future.
Financial accounts report on the business or company as an entire entity. Management accounts report on each department or division separately and dissect its situation in its own right. Therefore, a business or company has one accounts department which only deals with one entity. However, each division or section creates or compiles it own management accounts and reports.
Financial accounts are produced for external stakeholders. Management accounts are produced for the benefit of those inside, in other words for internal consumption. Financial accounts are prescribed by law and even by
international accepted practices. For, instance, it is compulsory for a listed company to annually submit financial statements in accordance to international practices. There are no laws or rules governing management accounts.
Financial accounts show the overall picture of a business’s financial position for a certain reporting period. As it is aim for dissection, evaluation and scrutinizing by the public, information contained in it is not confidential and not specific. On the her hand, management accounts need to provide specific information, for example the cost of each product separately, which can be used to carry out evaluations on each separate section of the business.
As prescribed in international accepted practices financial accounts must be accurate and correct. Although accuracy is also applicable to management accounts, it is not taken to extreme degrees. Management accounts’ emphasize is more on non-financial data, for example down time of machines, maintenance costs of machinery, productivity of shift workers, etc. It is usually issues that are difficult to express in monetary terms but which impact on monetary issues.
But what are the similarities as it seems all the above-mentioned relates to differences? Both rely on the accounting information delivery system, and both report on financial aspects of a business or company. See these two aspects as an iceberg. Financial accounting is the tip of the iceberg, visible to all to see. Management accounting is the rest of the iceberg; it is the part that is not visible to those outside the business or company. It supports the tip – or in other words the tip is part of the ice berg – accounting per se. The end result is that management actually needs the entire iceberg – meaning that both types of accounting, financial and management play an equal important role in the sound management of a business or company.