What is the Difference Between Financial, Cost and Management Accounting?

Financial, Cost and Management Accounting are the three main branches of accounting. All these three branches have different purposes. While financial accounting is for both public and private use, cost and management accounting are only for internal purposes. 

Table of Contents

• Difference between Financial, Cost and Management Accounting
• What is Financial Accounting?
• Types of Financial Accounting
• What is Management Accounting?
• Types of Management Accounting
• What is Cost Accounting?
• Types of Cost Accounting

Difference between Financial, Cost and Management Accounting

Financial accounting is used for preparing financial statements and financial reporting. On the other hand, management accounting is meant for the internal purpose of the organizations. Cost accounting is a part of management accounting through which company plans its costs. Let us now look at other parameters based on which these three branches of accounting are differentiated.

What is Financial Accounting?

Financial accounting is an accounting branch that involves recording, summarising and reporting business transactions over a period of time. These transactions are summarised in financial statements. Financial accounting follows Generally Accepted Accounting Principles for preparation of financial documents.

Types of Financial Accounting

There are following types of financial accounting: accrual and cash methods. In some cases, these two are together utilised for proper financial accounting.  

1. Accrual Method

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

The accrual method presents the financial performance of a company during a specific time period. Through this method of financial accounting, businesses can identify their profitability. 

2. Cash Method

Cash accounting is a method of financial accounting in which payment receipts are recorded when actually received. Expenses are recorded when actually paid. This accounting method is used by small-scale businesses since it is straightforward and simple. If an organisation follows GAAP, then it must follow the accrual accounting method.

What is Management Accounting?

Management accounting is an accounting branch in which professionals prepare financial statements and reports for management. Through these financial documents, management can make better business performance-related decisions. Some of the important functions of management accounting include planning, forecasting, organizing and coordinating.

Types of Management Accounting

There are seven types of managerial accounting:

1. Cash Flow Analysis

Cash flow analysis helps in identifying the impact of cash on various business decisions. By implementing working capital management strategies, businesses can optimise the cash flow. It ensures that the company has enough liquid assets so that it can cover short-term obligations. 

2. Inventory Turnover Analysis

Managerial accountants can determine the carrying cost of inventory to understand the expenses that are incurred to store unsold items. In case there is excess inventory, accountants may make changes for reducing storage costs. This frees the cash flow that can be used for other productive operations. Through inventory turnover, businesses are able to make wiser decisions related to manufacturing, pricing as well as marketing of inventory. 

3. Product Costing

Product costing determines the total cost to produce any good or service. This includes variable, fixed, direct and indirect costs. Cost accounting is used to identify these costs. Companies may assign overhead to products that it has created. Accountants allocate the overhead charges to determine total expenses incurred in the production. 

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4. Accounts Receivable (AR) Management

Accounts receivable means the payment that needs to be received. This happens when company extends its credit facility to customers. This gives rise to accounts receivable (AR) in the financial statements. If this is appropriately managed, then it will have a positive impact on company’s bottom line. Through AR management, businesses can determine customers who are credit risk. Based on this, the business can reconsider its decision on whether it wants to extend a credit line to that customer or not. 

5. Financial Leverage Metrics

It is the use of borrowed capital to acquire assets and increase ROI. Through balance sheet analysis, accountants choose the tools that are required to study company’s equity and debt to optimise leverage. Management can find out information on the borrowed capital via performance measures.

6. Budgeting

Accountants use performance reports for understanding the deviations from the actual results through budget. The budget-to-actual variance indicates either positive or negative deviations from budgets to make changes required for the future.

7. Constraint Analysis

In this management accounting, constraints are reviewed within the sales process and the production line. Businesses can identify the areas with bottlenecks. They can also calculate the impact of constraints on cash flow, profit and revenue. This information is useful to improve processes and thus, increase the efficiency of the sales process. 

What is Cost Accounting?

Cost accounting is an accounting branch in which the total cost of production is calculated. Accountants assess input costs including fixed and variable costs at every step during production process. Costs are measured individually and recorded. After that, input costs are compared with the output. This helps measure financial performance and make business-related decisions accordingly.

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Types of Cost Accounting

There are four types of cost accounting methods:

1. Activity-Based Costing (ABC)

ABC identifies the overhead cost from each department and assigns it to the specific cost objects. This activity-based accounting system involves tasks associated with a goal such as setting up machinery, distributing finished goods, etc. Such activities are the basis of overhead cost allocation. It is an accurate system to review the cost and profitability of company’s products and services. 

2. Lean Accounting

Lean accounting improves the financial management practices within an organization. It uses principles of lean manufacturing and production. As per the principle, minimum waste leads to productivity. Lean accounting can replace traditional costing methods with the help of value-based pricing. 

3. Marginal Costing

Marginal costing assesses the impact of varying levels of costs as well as volume on operating profit. This is allso known as cost-volume-profit analysis. Marginal costing determines the breakeven points of different sales volumes and cost structure. It is useful for businesses to make short-term economic decisions. 

4. Standard Costing

This type of costing assigns standard costs to inventory and Cost of Goods Sold (COGS). Standard costing is based on the efficient use of materials and labour for producing goods and services as per standard operating conditions. The company must pay actual as well as standard costs.  

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