In addition to giving you the financial information you need to pay your taxes and apply for financing, accounting can give you the data you need to understand your operations and make your business more profitable. These functions fall under the scope of management accounting because they are valuable for managers when making decisions and improvements.
TL;DR (Too Long; Didn't Read)
The application of management accounting in an organization can include everything from tracking productivity to understanding sales trends.
Uses of Management Accounting
- Productivity. To explain the use of management accounts and management information systems in performance management, you only need to collect and evaluate data about employee output relative to hours or payroll. If you track production and find that, on average, it takes about 15 minutes of labor to produce one unit you sell, you can use this information to evaluate outcomes when you change variables.
For example, if you purchase a new piece of labor-saving equipment, you can track productivity before and after you begin using it to determine how much effect it has on your payroll and your bottom line.
- Sales trends. By using management accounting, you can evaluate in detail which products and accounts are earning you the most money. Sales figures can help you to pin down whether your products are attracting a particular demographic and whether it's advantageous to market particular products at specific times and at targeted places. This management accounting information gives you the tools you need to target marketing efforts and pinpoint your production numbers.
- Financial planning. Management accounting helps you to pay your bills and keep your business afloat. By understanding how much money you have available and how much cash you can expect to have during upcoming periods, you can make strategic decisions about when to borrow money and when to make long-term investments. Planning these moves carefully can save you the stress of running out of working capital and it can save you money on interest and late fees.
The Scope of Management Accounting
Management accounting covers any financial analysis that provides you with useful information about business operations. It generally concerns itself with internal data, or numbers that you collect in the course of your operations that reflect the ways your company has been earning and spending money. It is not uncommon for a business to have separate individuals or departments in charge of collecting this information and others responsible for analyzing and evaluating it.
Management accounting falls under the purview of managers because it involves big-picture insights and observations. Someone who sees what is going on in a range of departments is in a better position to make useful assessments about the ways these areas overlap and interact than someone who only understands a limited slice of the pie.
Management Accounting and Financial Statements
Management accounting also uses many traditional accounting tools. These statements provide the low-hanging fruit of figures that have already been collected because you need to report sales and profit to tax agencies and you may need to compile balance sheets and cash flow statements for lenders or shareholders.
This information that you've assembled for external purposes can also prove useful for understanding what's working in your business and what isn't, and then making strategic changes. Management accounting looks at the same information through a different lens, using it for gleaning insights rather than simply for reporting purposes.
Your profit and loss statement tells you whether your margins are sustainable enough for your company to earn money over time. It is used in tax reporting to determine whether or not you owe taxes and, if so, how much. It is useful in management accounting by showing whether your margins are sufficient to pay your stakeholders and invest in growth. Because it is broken down into categories for earning and spending, it will also show you if there is a disproportionately successful source of revenue such as wholesale or retail sales, and whether there are areas where you are spending too much.
Your balance sheet shows how your profits and losses have played out over time, including whether you have more debt than assets and whether your assets are liquid and available for investments and emergencies. A balance sheet is useful for management accounting because it provides information to take into account in strategic planning. If all of your assets are tied up in equipment and real estate, it would be prudent to set some of your future earnings aside for operating capital. If you have weeks' worth of income tied up in accounts receivable, it may feel like you have no money but you can plan on receiving the bulk of those funds soon.
Advantages of Management Accounting
- Objectivity. Management accounting uses actual data to learn about how your business is succeeding and where there is room for improvement. Unlike empirical observation, which can be limited by an individual's perspective and availability, management accounting uses numbers that have been gathered over time.
- Flexibility. No two businesses approach management accounting in the same way. Unlike tax forms and traditional financial reports, your management accounting information is collected and evaluated for internal purposes only so you can organize it however you want and collect and analyze it on whatever schedule makes sense for your business, whether daily or monthly.
- Efficiency. It takes considerably fewer resources to review production numbers and identify areas where there is room for improvement than to sit back and let your business spend too much on inefficient processes. Even though the people analyzing data are usually paid more per hour than the people on the production floor, management accounting helps to make adjustments in processes where these savings show up week after week, year after year.
Disadvantages of Management Accounting
- False sense of security. Because management accounting works with objective numbers, it may create the sense that you fully understand a situation when the numbers actually don't reflect the whole story. For example, tracking the total number of production hours doesn't tell you about who is working or the morale level during a particular shift.
- Extra labor. Although management accounting provides insights that save you time and money, you must first invest the time and money to collect and assemble the relevant information. This requires an extra level of management and paperwork that may not make sense for your businesses, especially if you're struggling to cover payroll and meet urgent deadlines.
- Necessary level of skill. Not everyone can look over your company's numbers and be able to recommend the correct course of action. An experienced manager may be able to tie observations to trends that play out over time, but a less experienced observer may draw faulty conclusions based on insufficient knowledge.
Making the Most of Management Accounting
The key to leveraging the advantages and mitigating the disadvantages of management accounting lies in your ability to approach the process with a broad perspective and a clear sense of the potential pitfalls. Keep in mind that, although management accounting processes can be indispensable to your company, they should also be backed up with empirical observation. Avoid devoting time to management accounting that could be used for more urgent concerns but also try to staff your company sufficiently that you have the capacity to gather and analyze data.
Devra Gartenstein founded her first food business in 1987. In 2013 she transformed her most recent venture, a farmers market concession and catering company, into a worker-owned cooperative. She does one-on-one mentoring and consulting focused on entrepreneurship and practical business skills.