Management Accounting

Updated on April 11, 2024
Article byRutan Bhattacharyya
Edited byRutan Bhattacharyya
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Management Accounting?

Management accounting or managerial accounting is an accounting method that involves creating statements, documents, and reports to help the management team make better operational decisions. Its primary objective is to help organizations efficiently perform their key functions (planning, directing, controlling, and organizing).

Management Accounting

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Professionals involved in this practice must analyze multiple operational metrics and events to convert the data into information useful for business decisions. In addition, they try to provide comprehensive information regarding individual product lines, facilities, and operating activities to the management. Finally, it utilizes performance reports to identify deviations between actual results and prepared budgets.

Key Takeaways

  • The management accounting definition refers to a process that involves sending financial resources and data to managers to make better business decisions.
  • There are various management accounting techniques. Some popular ones are capital budgeting, accounts receivable management, cash flow analysis, and constraint analysis.
  • There are various advantages of management accounting. For example, it helps assess the performance of departments and employees and improves operational efficiency. Moreover, managerial accounting makes the information managers use to make crucial operational decisions more reliable.
  • Tracking KPIs and budgeting expenses are two examples of business activities involving managerial accounting.

Management Accounting Explained

The management accounting definition refers to recognizing, interpreting, analyzing, measuring, and communicating financial details to the managers so that they can take prudent decisions and achieve the organization’s objectives. This process occurs at different company levels and involves managers of different departments and teams. First, management accountants prepare estimates, schedules, and budgets. Then, they present them to the organization’s senior management to help them make informed decisions that can lead to better performance.

This practice encompasses various aspects of accounting that aim to enhance the quality of financial information sent to the management team. For example, cost accounting is a significant subset of managerial accounting; it focuses on capturing an organization’s overall production cost by evaluating fixed and variable costs at every step of the production process. This enables companies to minimize unnecessary expenditures and maximize profits.

Some vital business activities involving managerial accounting are as follows:

  • Estimating variable expenses and sales
  • Budgeting expenses
  • Monitoring KPIs r key performance indicators to evaluate the progress
  • Setting objectives for departments, teams, specific employees, and the organization

Managerial accounting is essential for companies as it enables them to convert hard data regarding finances into information that they can analyze and use to make better decisions. After all, in organizations, financial accounting is useless unless the management team uses the insights provided by managerial accounting to perform crucial organizational functions like planning and controlling.

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Functions of Management accounting

Some key functions of managerial accounting are as follows:

  • Provides Financial Details: The primary focus of managerial accounting is to provide financial details to the management. Moreover, it ensures the presentation of data in a format that allows individuals at every management level to make decisions and review policies.
  • Decision Making: One of the main objectives of this practice is to provide relevant information to the management so that they can take prudent business decisions. Historical data forms the basis for developing alternatives, estimating future effects, and deciding the best action.
  • Cause And Effect Analysis: Financial accounting is restricted to preparing the balance sheet and profit and loss account. Afterward, managerial accountants analyze the cause and effect of the numbers and facts. This means managerial accounting involves examining the causes of profits or losses. In the case of profit, the variables influencing profit are also analyzed. Moreover, the managerial accounting practice involves comparing the profit amount with sales, capital employed, expenditures, etc., to draw the right conclusions regarding the impact of the elements on the profit earned.
  • Utilization Of Special Concepts And Methods: Managerial accounting uses special methods like cash flow, budgetary control, ratio analysis, standard costing, etc., to make the financial information more useful for the management. Each technique is valuable for a particular purpose, such as establishing operational control, data analysis and interpretation, etc.

Techniques

Let us look at some common management accounting techniques.

#1 – Cash Flow Analysis

This technique assesses how business decisions impact cash flow. As a result, it can give organizations a better idea regarding the optimal strategies and working capital required to cover short-term liabilities, increase assets’ liquidity and maximize cash flow efficiently.

#2 – Constraint Analysis 

Constraint analysis involves analyzing a business’s production lines to assess the principal bottlenecks, the inefficiencies established by them, and their effect on an organization’s ability to earn profits and revenue. In other words, this aspect of managerial accounting measures the impact of production constraints on profit, revenue generation, and cash flow. Organizations can use the information to develop strategies to increase production efficiency and sales.

#3 – Trend Analysis And Forecasting 

Trend analysis and projection mainly focus on identifying product cost trends and patterns. Moreover, recognizing unusual deviations from the estimated values and identifying the reasons behind such deviations are two other key focus areas of this management accounting technique.

#4 – Capital Budgeting 

Capital budgeting primarily involves analyzing the details necessary to make capital expenditure decisions. For example, in the case of capital budgeting analysis, a company’s management accountants compute the IRR or internal rate of return and the NPV or net present value to help the managers make capital budgeting decisions.

#5 – Product Costing And Inventory Valuation 

This technique focuses on figuring out the actual cost of the products and services offered by the organization. The process typically involves evaluating direct costs related to the cost of goods sold and calculating the overhead charges.

#6 – Accounts Receivable Management 

Management accountants assess the receivables to understand the collection efficiency and payment techniques. This, in turn, helps them to reduce credit risk exposure.

Examples

Let us look at a few management accounting examples to understand the concept better.

Example #1

Suppose Matthew, the human resource manager of Panther LLC, wants to see a graph showing employees’ salaries over a specific duration. The organization’s management accountants can fulfill the requirement by providing the details in the specific format the HR department needs.

Example #2

Suppose Jacob, the purchase manager at a footwear manufacturing company named Amacon, is looking to purchase equipment for the business that can increase production. He can avail of a loan to finance the purchase or buy the equipment by paying the entire amount in one go.

The organization’s management accountants may run multiple scenarios by Jacob showing the cash outlay needed to purchase the equipment outright versus the cash outgo over time with an unsecured loan at different interest rates.

Advantages And Disadvantages

Let us look at some benefits and limitations of managerial accounting.

Advantages

  • It increases the operational efficiency of companies.
  • Planning and formulation of policies can become more effective because of this practice.
  • Managerial accounting can help an organization’s management team take decisions that can maximize profit.
  • The techniques used in managerial accounting generally make the accounting data sent to the management reliable and accurate.
  • Another key advantage of management accounting is that it can help assess departments’ and employees’ performance using control ratios, variance analysis, etc.

Disadvantages

  • Managerial accounting is based on information and data received from cost and financial accounting. Hence, its reliability depends on the effectiveness of the organization’s financial accounting and cost accounting system.
  • Installing a managerial accounting system is typically very expensive. Therefore, companies with a low budget cannot install it.
  • Personal bias and interpretation of the top manager of a company may impact the interpretation and analysis of financial information.
  • The scope of managerial accounting is very wide; it utilizes information from multiple disciplines, like statistics, economics, and financial accounting. Thus, limitations of the experience and knowledge of management accountants in such fields can make financial data unreliable.

Frequently Asked Questions (FAQs)

When did management accounting start?

Management accounting started in the late 1950s.

How often should management accounting reports be prepared?

Usually, management accountants prepare reports every month or once a quarter.

What are management accounting reports?

Cost estimates of products already existing in a company’s portfolio, operational budgets, profit and loss reports, and budgets for upcoming product lines are a few examples of reports published by management accounting.

How management accounting is different from financial accounting?

Some key financial and managerial accounting differences are as follows:
– Financial accounting focuses on historical data, which includes reports of the previous quarter or year. In contrast, managerial accounting focuses on present data and future estimates. 
– Financial accounting reports have a particular format. That said, managerial accounting reports are informal. Their format depends on the requirements of a department or company. 
– Financial accounting follows generally accepted accounting principles (GAAP). On the contrary, managerial accounting does not follow GAAP.

This article has been a guide to what is Management Accounting. We explain its advantages, functions, techniques, examples, and disadvantages. You may also find some useful articles here:

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