Oct 13, 2021Accounting 101: Financial and Managerial Differences
Financial Accounting vs. Managerial Accounting
When it comes to examining and reporting the financial health of a company, there are two main accounting processes that companies use: financial and managerial accounting. While these two methods may seem related, they differ greatly in their purpose, process, and use. This article overviews the main differences between each method and details their unique characteristics.
Financial & Managerial Accounting Key Differences
One of the biggest differences between financial accounting and managerial accounting is the purpose behind these methods. While financial accounting is used to prepare financial materials for both internal and external use (e.g., investors, lenders, etc.), managerial accounting is used solely for internal purposes. This means that while financial accounting methods need to be standardized across the United States, managerial accounting methods can vary from company to company, and even from department to department. The adaptability of managerial accounting allows companies to address specific problems on a company and department level.
Financial Accounting Characteristics
Financial accounting comes into play when a company is preparing its financial statements, like its balance sheet, income statement, and cash-flow statement. Companies will employ Certified Public Accountants (CPAs) to prepare these documents, and the CPAs will use the generally accepted accounting principles (GAAP) that are standard across the United States. These financial documents and reports are normally prepared at the end of an accounting cycle.
Within financial accounting, two sub-methods determine how a company’s finances are recorded: accrual basis and cash basis accounting. Some companies may use a combination of these two methods.
- Accrual Basis: This method records transactions as they occur, without the receipt of physical payment.
- Cash Basis: This method records transactions only when cash is received, or a payment has been fulfilled.
Financial accounting presents financial data under the following five categories:
- Revenues (reported on the income statement)
- Expenses (reported on the income statement)
- Assets (reported on the balance sheet)
- Liabilities (reported on the balance sheet)
- Equity (reported on the balance sheet)
While these reports can and should be used internally, financial accounting processes operate under the assumption that outside investors and lenders will use and be aware of the compiled financial data, which is why this process is standardized across the country.
Managerial Accounting Characteristics
Unlike financial accounting, managerial accounting is used internally to help financial managers make wise choices for their company. Because managerial accounting prioritizes internal financial management, managerial accounting processes can vary, depending on the needs of a company or department. As a result, managerial accounting is not restricted to general accounting standards like financial accounting.
Companies will hire Certified Management Accountants (CMAs) to perform managerial accounting processes. CMAs examine several financial factors and compile a variety of reports to aid financial managers in making financial improvements and adjustments in their company. Managerial accounting generally creates the following reports:
- Product Costing and Valuation (also known as Cost Accounting): Examines how much a company spends to produce a good or service.
- Cash-Flow Analysis: Examines the impact of specific financial decisions, such as acquiring a new asset.
- Inventory Turnover Analysis: Examines the impact of maintaining unsold inventory, which involves analyzing the amount of inventory sold versus the inventory left over during a period.
- Constraint Analysis: Examines the production and sales processes to remove any obstacles that hinder productivity.
- Financial Leverage Metrics: Examines company debt in comparison to company equity, allowing companies to make adjustments before answering to external entities.
- Accounts Receivable (AR) Management: Examines customer reliability and helps management know when a customer becomes more of a risk than an asset.
- Budgeting, Trend Analysis, and Forecasting: Examines overall financial goals, trends, and performance to make future adjustments as needed.
In this way, managerial accounting becomes a much more individualized method for assessing the strengths and weaknesses of a company’s financial situation.
While distinct processes, both financial accounting and managerial accounting have an important place in any company. This article overviews the main points behind these methods, but more detailed information can be found in the following articles: “Financial Accounting,” “Managerial Accounting,” “How Financial Accounting Differs from Managerial Accounting,” and “What Is the Difference Between Financial Accounting and Managerial Accounting?”