Many small business owners consider accounting a tedious chore that cuts into time they could be spending at more interesting and satisfying activities like developing new products or engaging with customers. However, some accounting tasks provide interesting and relevant information that can make a business more effective and efficient, increasing the time available to do the more enjoyable work.
Management accounting uses financial accounting reports for planning and decision making, helping you to make informed and strategic choices that make your company a better, smarter business.
Management accounting information is the collection of reports and data that managers use to make financial decisions.
Financial Accounting vs. Management Accounting
Many accounting tasks are geared toward compiling the paperwork and reports that your business is required to provide for outside agencies and stakeholders. Government agencies require you to fill out tax forms and remit taxes based on financial accounting information. Banks require you to provide financial reports when you apply for loans and subsequently when they monitor your fiscal well-being throughout the term of a loan. Shareholders and investors are entitled to regular financial information that apprises them about the effects of their investments.
In contrast, management accounting prepares financial information for internal use, specifically for making managerial decisions and strategic plans. This information can include anything that your managers find relevant or interesting and anything that will shed some objective light on your company's workings and its potential to increase profitability. This extra layer of relevance and usefulness can elevate management accounting from a headache to a godsend.
Financial accounting prepares statements based on generally accepted accounting principles that ensure some degree of rigor and consistency across industries and within individual businesses. Management accounting information includes some of the same reports as financial accounting, but the rules for measurement and reporting for management accounting need only meet your internal standards for accuracy and usefulness because these figures will usually only be reviewed and used by your own staff.
Management Accounting and Financial Statements
Statements compiled for financial accounting provide low-hanging fruit for gleaning management accounting information. Your accounting staff has already done the work of preparing these numbers for outside agencies, but you can use the same information for internal purposes as well.
- Profit and loss. Your profit and loss statement shows how much your business has earned and spent during a specific period, such as a month, a quarter or a year. Financial accounting must prepare these statements for income tax reporting and accountability to other external agencies. These statements are also useful for management accounting because they show your gross and net margins and where your business needs to cut costs or increase revenue.
- Balance sheet. Your balance sheet shows how much your business owns, how much it owes and how these assets and liabilities are distributed. Corporate tax forms require you to submit balance sheets, and banks and investors are especially interested in balance sheet information because it provides valuable insight on your company's financial stability. Management accounting can make use of the same information for planning as you determine whether you need to pay off debt more quickly or whether you need access to more liquid cash.
- Cash flow statement. This financial document lays out your company's cash position, showing whether you have enough capital available to meet current operating costs and external financial obligations. Lenders and investors consider it a key piece of the puzzle that shows your company's overall financial health. This statement is also invaluable for management accounting because it shows in detail how much financing your company may require and when it will be prudent to cut back on spending.
Understanding Cost Accounting
Cost accounting falls under the domain of management accounting, though it is largely irrelevant to financial accounting for external purposes. This management accounting information provides indispensable insights on how much your various products and services cost your company to produce or provide and which yield the greatest profit.
Cost accounting is closely tied to cost of goods sold, a line on your profit and loss statement that reflects how much you have actually spent to produce your offerings as opposed to the other infrastructure costs associated with running your business. Cost of goods sold is then used to calculate gross margin, or the percentage of your revenue left over after subtracting these direct operating costs. Although cost of goods sold and gross margin provide valuable pieces of information for management accounting, these figures only provide broad averages.
To assess and improve profitability, your business can also break down costs for each of its products or services, especially the direct labor and materials that go into providing them. If your business manufactures shoes, this exercise will show you which of the designs you offer cost the most to produce and which yield the highest profit. This information can help you to make strategic decisions, such as whether to aggressively promote the more profitable design and whether to discontinue the one that earns less net income.
Understanding Productivity Figures
As part of its management accounting efforts, your business can also collect information about the productivity of your production systems. The specifics of gathering this data can be unique to each individual business, but the general idea is the same: evaluating the time it takes to get a job done relative to the specific output, such as number of units produced. Like cost accounting, productivity figures can provide insights on which of your offerings are cash cows and which put a strain on your margins.
Productivity data can also help you to improve efficiency by providing objective information regarding how long it takes to produce a batch of products and which variables affect this productivity. It may look like your manufacturing division is operating efficiently because it always gets the job done, but once you start tracking hours relative to output, you may find that it's costing you too much, and you're dedicating too much of your payroll expenditures to a particular production process.
Management accounting enables you to improve productivity by observing the effects of changes that may seem insignificant but can have far-reaching consequences. Tracking production data helps you to find the ideal number of people to have on the shop floor and the ideal batch size to produce before production starts to get bogged down or backed up in bottlenecks. The extra time spent collecting this data can easily pay for itself with time saved implementing changes based on your observations.
Understanding Sales Data
Tax agencies are interested in your overall sales figures as the basis for your tax reporting, but they really aren't concerned with what is selling well, who is buying it and where your sales are strongest. However, this information has far-reaching consequences for your company's potential to earn a profit.
If you can identify your strongest sellers and understand why they are so successful, you will have useful information for increasing sales and ultimately improving your bottom line. By tracking sales by product over time and location, you can see seasonal fluctuations, unexpected surges and changes occurring at different sales venues.
Of course, the usefulness of this information depends on your management accounting staff's ability to recognize correlations with internal and external events and to subsequently test these theories. You may notice that a particular product sells especially well on sunny days, but it may be just as reasonable to draw the conclusion that this product sells well with tourists, and there are more tourists in town during sunnier times of the year. You can test these conclusions by reviewing sales data from sunny days during the tourist off season and also rainy days during peak tourist times of year.
Management accounting can also provide useful information about sales by evaluating figures from different staff members. Some of your sales staff may show consistently stronger numbers than others, and these discrepancies may come from the different shifts they work, the different areas they cover or their different personalities or levels of enthusiasm. You can test hypotheses by rotating staff members between locations, and you can also use sales data to create benchmarks or reasonable expectations for daily or monthly sales.
About Financial Planning
Financial accounting's cash flow statement provides details of your current cash position, but management accounting provides the primary source of information for projecting into the future and anticipating and addressing cash flow shortfalls. A cash flow pro forma is a valuable tool for looking ahead to see when you will be short of cash and by how much and when you will have extra funds to spend and to save.
A cash flow pro forma, or projection, lists all of your sources of available cash, including funds left over from previous accounting periods, incoming revenue from sources such as retail and wholesale sales and money from loans you may secure during the upcoming period. In a separate section, it also lists all of your outgoing expenditures such as rent, production materials, vehicle expenses, utilities and loan principal and interest. By subtracting outgoing from incoming cash month by month, you can see when you're headed for a cash flow crisis.
Management accounting uses this information as the basis for securing financing. By looking at the amount of the deficit you will incur at the lowest point in your annual cycle, you can see how much you will likely need to borrow. Alternately, you can use the information on your cash flow pro forma to determine a good time for making a sales push to increase revenue or tightening spending so you have more available funds.
Managing Growth for Your Business
Management accounting information can also provide the basis for evaluating how and when to grow your business. All of the data coming in about sales, costs and available cash enter into these determinations, which also depend on your management team's ability to understand and process the available numbers to make successful calls. The very fact that your business needs more money doesn't necessarily mean that you should invest in a new product or new market. You may not have access to sufficient capital to do justice to this move, or you may not yet sufficiently understand what your customers want or need.
To use management accounting information for planning growth, you must bring together data from diverse parts of your business to provide the background you need to make determinations. You must also research potential costs and markets to make the best assessments you can about how your new ventures may be able to pay for themselves and in what time frame.
Of course, there is no way to forecast sales of a new product in a new market with complete accuracy. However, if you understand your company's past performance and current cost trends, you can use this information to make educated predictions for future endeavors.