Accounting: Managerial vs. Financial
The similarities and differences between the two.
Key Takeaways
Financial Accounting involves reporting on past transactions and events, whereas managerial accounting is more focused on the future.
They both involve collecting financial information and presenting it to their target audience in the form of financial reports.
In financial accounting, the target audience is external. And in managerial accounting, it's internal.
Financial Accounting
Financial Accounting is the process of recording summarizing and analyzing an entity's financial transactions and reporting them in financial statements to its existing and potential investors, lenders and creditors.
Managerial Accounting
Managerial or management accounting is the process of identifying, measuring, interpreting and communicating information to management to assist them in planning, decision making and risk management.
How are they similar?
They're both branches of accounting. Accounting, which has been referred to as the “language of business” is a huge field of study that can be divided up into several different practices. Things like financial accounting, managerial accounting, tax accounting, audit, bookkeeping, and forensic accounting are all different branches of the same tree. Financial and management accounting are just two of those branches. They both involve collecting financial information and presenting it to their target audience in the form of financial reports. But to what target audience and which financial reports is wherein the differences lie between financial and managerial accounting:
Target Audience
In financial accounting, the target audience is external. And in managerial accounting, it's internal. Let me explain how that works. Both the Financial Accounting Standards Board and the International Accounting Standards Board, who respectively come up with US GAAP and IFRS stated the primary users of financial statements are an entity's existing and potential investors, lenders and creditors. That's because the main objective of financial accounting is to report on a business's financial health to these external parties. That's not to say that other groups of people like management regulators and the public won't find financial statements useful, but keep it in mind that existing and potential investors, lenders and creditors are the main reason why financial statements exist to protect these external parties that are funding or potentially going to fund the business.
In contrast to this in managerial accounting, the target audience is all internal. The main objective here is to create internal reports to help the managers within the business plan for the future, make informed business decisions and manage risks which in turn will impact on performance and profitability.
Financial Reports
Financial Accounting involves reporting on past transactions and events, whereas managerial accounting is more focused on the future. Financial accountants put together reports like the income statement and the balance sheet to summarize transactions that happened over a period of time or the closing balances of assets, liabilities, and equity at a single point in time. In the past, this period of time or point in time that we're talking about is always in the past. It’s the historical information that financial accountants rely on to build these financial statements.
On the contrary, management accountants make reports to help management make decisions that impact the future like budgets or forecasts, which determine how a business chooses to allocate its resources.
Scope
Next up, I'd like to talk about scope because this is completely different for both of these accounting branches. In financial accounting, the scope is Broad Financial Statements consolidate the results of all of the different departments and business units so that external parties can get an understanding of the big picture of the whole business.
Meanwhile, in management accounting, the scope is much more narrow management accountants like to slice a company up into different segments, divisions and cost centers to provide the managers of all of these different areas with detailed reports to help them specifically, these reports might not be limited to financial information either. They might contain non financial information like detailed commentaries or explanations to help support the data by telling the story and that leads me nicely into difference
Priority
In financial accounting, the focus is always on being objective and precise. Financial statements are meant to reflect a true and fair view of a business's state of affairs at the end of an accounting period. No “guesstimates” are allowed.
In managerial accounting, the priority is on being relevant and timely. What use is a super accurate report if it comes to a manager too late and isn't relevant anymore? For this reason, management accountants are given more leeway to use estimates and shortcuts if it means that they can deliver their analysis on time estimates and shortcuts. Sounds a bit dodgy don't management accountants have some rules to follow. Not really, because their reports and analysis are confidential and for internal use only.
Regulation
Management Accounting is less regulated than financial accounting. There's no framework to follow so their reports can take on whatever format they like.
However, financial accounting is heavily regulated. Remember when I talked about GAAP and IFRS earlier on? Well, these are the principles and standards that financial accountants have to adhere to GAAP and IFRS lay out a strict roadmap. They'll show us how we should record transactions and present that information and financial statements like the income statement, the balance sheet and the statement of cash flows. And that's no wonder really, since the uses of these statements are external, they need to be protected from fraud and misinformation. And on top of that, financial statements sometimes need to be audited audit is a completely different branch of accounting, where a business hires an independent external group of accountants whose job it is to review and check over financial statements before they can be approved and sent out to the external lenders and investors.
Management and Financial Accountants
Financial accountants become essential once a business grows above a certain threshold.
While management accountants are technically not required, you can think of them more as a luxury that companies don't necessarily need, but can be extremely valuable when it comes to making decisions about strategy in the future.
So which is better?
As an external investor, you'd obviously value financial accounting because the internal reports created by management accountants are confidential so you never see them. That being said, you would hope that the business is making use of managerial accounting to plan for the future, make informed decisions, and reduce risks where possible. For most, financial accounting is an absolute necessity. However, managerial accounting can be extremely valuable when it comes to impacting future performance and profitability.