Difference Between Financial Accounting and Management Accounting

Accounting has three main types including cost accounting, financial accounting and management accounting. All three types serve different purposes and functions. In this article, we will discuss the difference between financial accounting and management accounting.

Table of Contents

• Difference between Financial Accounting and Management Accounting
• What is financial accounting?
• Types of financial accounting
  • Accrual Method
  • Cash Method
• Functions of Financial Accounting 
• What is managerial accounting?
• Types of Management Accounting: 
  • Cash Flow Analysis
  • Inventory Turnover Analysis
  • Product Costing
  • Accounts Receivable (AR) Management
  • Financial Leverage Metrics
  • Budgeting
  • Constraint Analysis
• Types of managerial accounting  
• Functions of Management Accounting

Difference Between Financial Accounting and Management Accounting

As we have taken a detailed look at financial and management accounting, let us now learn the difference between the two. 

Both accounting branches provide financial information but they serve different purposes. You cannot identify the importance of one branch over another and it is not necessary. We hope this article has been able to help you understand the difference between the two.

What is Financial Accounting?

Financial accounting is one of the branches of accounting. It involves the process of recording, summarising and reporting business transactions over a period of time. These business transactions are summarised in financial statements. This branch of accounting involves the use of globally accepted accounting principles.

These are Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Here financial statements represent five classifications of the data: revenue, assets, liabilities, expenses and equity. Asset, liability and equity are reported in the balance sheet which uses the financial data for future economic benefits. Expenses and revenue are reported on the income statement.

Types of Financial Accounting

There are two main methods of performing financial accounting: the accrual and cash methods. In some cases, the combination of the two methods is also utilised for financial accounting. 

1. Accrual Method

Through the accrual basis of accounting, companies record the revenue before receiving the payment for their products. Revenue is recorded in the accounting books of the company before the actual cash transaction takes place. This accounting method is based on the matching principle which says that expenses and revenues must be recognized in the same period. 

Accrual accounting reflects the financial performance of a company during a time period. They can correlate expenses and sales during the same accounting period. Through this method, businesses can identify their profitability. 

2. Cash Method

Cash accounting is a method where payment receipts are recorded when they are actually received. Similarly, expenses are recorded when they are actually paid. Small-scale businesses use this accounting since it is more straightforward and simple. 

However, if an organisation is following GAAP, then it must opt for an accrual accounting method. Cash accounting is less accurate since they affect the company’s books with delay when the transaction actually takes place.

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Functions of Financial Accounting

The following are the functions of financial accounting:

1. Systematic Record of Transactions: With thousands of transactions taking place, it is impossible to keep a track of every transaction. Through financial accounting, an orderly method for recording every transaction is provided. The recording process takes place through ledgers, journals as well as other books of accounts.
2. Complying with Legal Requirements: Financial accounting helps in meeting the legal requirements while creating financial statements. These include adhering to Generally Accepted Accounting Principles (GAAP) and Indian Accounting Standards (IND AS).
3. Summarizing Financial Records: The accounting teams create a financial record after analysing as well as summarizing transactions in trial balance. In the end, the final statement displays the profits and losses of an organization during a financial year.
4. Communicating Results: Financial accounts helps organizations in sharing their annual financial performance with shareholders, investors, lenders, government bodies, creditors and debtors.

What is Management Accounting?

Management accounting is a branch of accounting in which professionals create financial statements, documents and reports for management. Through these resources, management is better equipped to make wise business performance-related decisions. Functions of management accounting include forecasting and planning, organizing, coordinating, performance variances, etc. Managerial accounting has the following functions:

• Source of data: The historical data recorded through management accounting can offer insights to forecast future trends in business. 
• Making decisions: It offers insight into the cost and production availability, which are the deciding factors in the purchase choice. 
• Forecasting cash flows: Through these accounting methods, management can create budgets and trend charts for fund and resource allocation to generate the projected revenue.
• Rate of returns: Management accounting helps in identifying the investment with a better rate of returns. This allows wiser investment decisions before getting into a project. 

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Types of Management Accounting

There are seven main types of managerial accounting:

1. Cash Flow Analysis

Managerial accountants perform cash flow analysis to identify the impact of cash on business decisions. Implementation of working capital management strategies helps in optimising the cash flow. It also ensures that the company has sufficient liquid assets to cover short-term obligations. In comparison with accrual accounting, cash flow analysis helps in understanding the cash impact of a single financial transaction. 

2. Inventory Turnover Analysis

This indicates the frequency of selling and replacing inventory in a given period of time. Managerial accountants can identify the carrying cost of inventory which helps in understanding the expenses incurred for storing an unsold item. If there is excess inventory, they could make changes to reduce storage costs and free the cash flow for more productive operations. Through inventory turnover, businesses can make wiser decisions on the manufacturing, pricing, marketing and purchasing of inventory. 

3. Product Costing

It helps in determining the total cost for producing a good or service. It includes fixed, variable, direct and indirect costs. To identify these costs, cost accounting is used. Companies assign overhead to every product that it creates. Accountants calculate and then allocate the overhead charges to assess the total expenses incurred in the production. This may be based on the number of products or production activities. Direct costs help in the accurate valuation of the cost of inventory and goods sold. 

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4. Accounts Receivable (AR) Management

Receivable denotes the payment that is yet to be received. This happens when the company extends a credit facility to its customers. This, in turn, gives rise to the accounts receivable (AR) in financial statements. If AR is appropriately managed, then it can have a positive impact on the company’s bottom line. Through the management of AR, businesses can identify customers who have become credit risk and may reconsider the decision to extend a credit line to that customer. 

5. Financial Leverage Metrics

It refers to the use of borrowed capital for acquiring assets and increasing the ROI. Through the analysis of the balance sheet, managerial accountants can choose tools to study a company’s debt and equity to optimise leverage. Management can identify information on borrowed capital using performance measures instead of outside sources.

6. Budgeting

Accountants can use performance reports to understand the deviations from actual results with the help of a budget. The budget-to-actual variance which indicates positive or negative deviations from budgets to make required changes for the future.

7. Constraint Analysis

This is also a part of management accounting where constraints are reviewed within the sales process and production line. They can identify the areas where there may be any bottlenecks. They can calculate the impacts of constraints on profit, cash flow and revenue. This information is used for improving processes to increase efficiency in the sales process. 

Functions of Management Accounting

The following are the functions of management accounting:

• Forecasting and Planning: This involves the use of old data to predict trends in the future which in turn, helps in planning. Once you analyse the results of the forecast, you can plan. Through planning, you can allocate resources, capital and set realistic for the future.
• Organizing: Another function of management accounting involves organizing human and non-human activities. Through management accounting, accountants can prepare budgets and ascertain individual cost center. Based on this, they can delegate the budget to different centres.
• Coordinating: Management accounting provides coordinating tools including budgeting, financial reporting, financial analysis as well as interpretation. Management accounting enhances the efficiency within the organization and increase its profits. This helps management by analyzing cost and financial accounts through the preparation of budgets, standard cost evaluation and cost variance analysis.
• Data Interpretation: Management accounting helps in analyzing informatiomn and presenting it to the management and authorities. Data analysis helps in appropriate planning and effective decision making for the same data presented in comparative statements, projected trends and ratios.
• Business Asset Protection: Management accounting professionals manage funds as well. It helps in maintaining, replacing and repairing and fixing the assets available in the organization. This helps in smooth and uninterrupted production flow that will otherwise impact company's profits. 
• Tax Policies: Another significant function of management accounting is related to tax policies. Management accounting professional prepare tax payment reports to present several authorities.