Definition: Management accounting can be defined as a process of identifying, measuring, analyzing, and communicating financial information to the managers of the organization so that they can make effective decisions that will be helpful for them to achieve the organizational goals.
Meaning and explanation of management accounting
Management accounting is also known as managerial accounting. The main goal of management accounting is to measure and share financial information with the managers of the organization to help them in better decision-making.
Management accounting is different from financial accounting as the purpose of management accounting is to help the internal team of the organization so that they make well-informed and active business decisions.
The financial administration shares the financial information in the form of financial balance statements, invoices, etc. with the managers of the organization. The managers of the organization use this statistical data to make relevant and useful decisions like controlling the business activities, enterprise, and development of the organization.
Objectives of Management accounting
The main aim of management accounting is to help the management team of the organization in making better and effective decisions. The financial information is shared with the managers so that they can perform business operations and other vital activities efficiently
There are several different objectives for using management accounting. Let us learn about them one by one.
Decision-making is the most crucial objective of using management accounting. The decisions made by managers are essential and play a vital role in deciding the future of the company. If the managers of the organization are well-informed about the financial health of the company, then they can make better and efficient decisions.
In accounting, different types of techniques such as costing, economics, and statistics, etc. from various fields are considered. This information is further presented in the form of charts, figures, and tables, which helps the managers to make well-verified decisions, as a result of which the chances of failure reduces.
Management accounting is a continuous and ongoing process. It does not have any strict timeline-like financial accounting.
Therefore, financial information in management accounting is shared with the management at regular intervals such as daily, weekly, monthly, etc. The managers of the organization use this pooled information to make decisions related to the business activities.
For example, if there is a reduction in the sales of a product, then the marketing manager can identify the reasons and can take appropriate actions to improve the sales of the product by introducing a lucrative offer on the product or by rectifying the mistakes made by the sales team.
Organizing resources is crucial for smooth business operations in the organization. It is the responsibility of the management to make sure that all resources are available in sufficient amounts so that work does not get affected. Management accounting helps the managers to organize resources better and efficiently.
4. Controlling business operations:
The management manages the business operations in an organization. The management is responsible for deciding the work to be done and giving instructions to the employees. The management can control the business operation in a better way with the information shared by the management accounting.
5. Understanding financial data:
Another essential objective of management accounting is to understand economic data. The data is presented in the form of tables, figures, and charts that help the management understand the information in a better way.
6. Strategic management:
The concept of management accounting is not necessary. Every organization can have a different structure of management accounting according to the requirement of the organization. For example, if a company feels it requires a more in-depth analysis and investigation of a specific field, then it can perform accordingly.
In this way, they can focus on the core areas of the business. The information presented through management accounting helps them in making strategic decisions. For example, if an organization is planning to launch a new product or to cease the production of an existing product; in such a scenario, the role of management accounting is very crucial.
7. Identifying business problem areas:
Management accounting is beneficial in determining the business problem areas. For example, if a product is not performing well or a particular department is running into losses, then with the help of management accounting, the managers of the organization can determine the underlying causes of the problem and can provide solutions accordingly.
The frequent access to the report and information enables the management to stay ahead of the problem, and they can provide solutions to the problem even before it exists.
Drawbacks of management accounting
Setting up a management accounting system and preparing regular reports is a costly process and requires enormous investment.
2. Less knowledge
The information presented by management accounting is in the financial and economic terms. The managers of the organization have less knowledge about commercial terms. Hence, sometimes, they found it difficult to understand the information provided by management accounting.
3. Outdated data
The management accounting creates reports based on the past data, and that data becomes obsolete when the management is finally making the decision. Therefore, the whole effort of management accounting becomes useless.
4. Data based on financial accounting
Most of the decisions taken by the management depend on the information obtained from financial accounting and not from the management accounting.
How does management accounting work?
Management accounting consists of several facets of accounting, whose purpose is to enhance the quality of the information that is needed to be delivered to the management related to the business operations.
The management accountants make use of the information related to the cost and sales revenue generated by the goods and services produced by the company.
The management accountants focus on the different aspects of management accounting, such as cost accounting, which is an essential and significant subset of management accounting. The focus of cost accounting is to calculate the total cost of production by including the different variable costs incurred at different steps of production.
Using this information, management can take measures to reduce unnecessary expenses and thus maximize the profits generated by the organization.
Types of management accounting
There are different types of management accounting. Let us learn about different types of management, one by one.
1. Cash flow analysis:
It is the job of a management accountant to calculate the impact of cash on business decisions. The financial information of several companies is recorded based on accrual accounting.
However, accrual accounting provides an accurate image of the financial picture of an organization. The management accountant might apply working capital management strategies to optimize the cash-flow in the organization and to ensure that the company has enough liquid assets to fulfill the current financial obligations.
In a cash flow analysis, management accounting considers the flow of cash in and out of the organization after the implementation of a particular business decision.
2. Product costing:
Product costing is concerned with the total cost involved in the production of goods and services. These costs can be divided into several categories, such as fixed cost, the variable cost, direct, and indirect costs. The purpose of cost accounting is to identify and measure these costs and divide the total overhead on each product produced by the company.
The management accountants calculate the total cost and allocate these overhead expenses related to the production of a single product by the company. The overhead costs are divided based on the number of goods produced by the organization or based on other activities that are related to production.
In addition to overhead costs, the management accountants are required to count the direct cost of products sold and the number of units left in the inventory at different stages of the production. Marginal costing or cost-volume-profit-analysis is the effect on the value of a good by adding one additional unit in the production. The marginal costing is useful in the calculation of short-term economic decisions.
Margin analysis then moves into break-even analysis, which means the estimation of a point where profit made by the sales of the product will meet the total expenses caused by the company in the production of the products. Additionally, the break-even analysis is also useful in deciding the price of products and services produced by a company.
3. Constraint analysis:
Management accounting is also concerned with the review of constraints in the sales process or the production line. It is the responsibility of the management accountant to calculate where exactly the bottleneck takes place and then calculating the effect of those constraints on profit made by the organization, revenue generated by the organization, and the flow of cash. This information is then used to make changes in the production of sales processes to increase their efficiency.
4. Inventory turnover analysis:
Inventory turnover analysis is the calculation for how many times a company has replaced or sold out its current inventory. Inventory turnover calculation helps the organization in making better business decisions such as purchasing new inventory, pricing, marketing, and manufacturing, etc.
Management accounting also calculates the carrying cost of the inventory. The carrying cost of stock is the total cost a company incurs in storing inventory in the organization. If a company is saving a massive amount of inventory, then there is a need to make efficiency improvements to reduce the cost of storage.
5. Budgeting, trends analysis, and forecasting:
Budget is an essential term for every business. It is used as a quantitative expression for the plan of operations of a company. Management accountants compare the performance report to see the deviation in the obtained results from the decided budget. The difference in the budget, either positive or negative, is referred to as budget-to-actual variance. The comparison is made to determine what changes the management is required to make in the future to obtain the desired outcome.
Also, the management accountant reviews the business proposals to decide whether the product or service is in demand or not and what methods are they going to use to finance the purchase. With this, they also outline the payback period so that management can predict the future economic advantage that they might get because of the business deal.
The management accountants also regularly review the trendline for certain expenses and analyze the deviation from the budget. It is vital for the management accountant to periodically review this information to have appropriate answers to the questions asked during the external audits.
6. Accounts receivables management:
Managing account receivables (AR) puts a positive impact on the bottom-line of the organization. The ageing report of the account receivables provides an AR report based on the length of time for which these have been outstanding.
For example, an account receivable report contains the list of outstanding receivables, which then 30days, 30-60 days, and more than 60 days. By the regular review of the account receivables, the accountants can signal the managers to indicate if a customer has become credit risk for the organization. For example, if a customer has a history of paying late often, then the manager can revise his decision to do any future business with the customer.
7. Financial leverage metrics:
Financial leverage is the capital borrowed by an organization to acquire assets and to maximize their return on investment. With the help of balance sheet analysis, the management accountant provides tools to the management that they need to study the equity mix and debt of the company so that leverage can be used at an optimal level.
Additionally, measurement of performance metrics such as debt to equity, return to investment, and return on invested capital helps the management to learn about the borrowed money before relaying these statistics to outside sources. The administration is required to review and measure the ratios and statistics to provide appropriate answers to the questions of creditors, investors, and board of directors of the organization.