As you continue reaching new heights in your accounting journey, you inevitably arrive at the crossroads of two key terms: managerial accounting vs. financial accounting. But wait, you might say, isn’t accounting both managerial and financial? This is a perfectly valid question! In fact, accounting has four major branches. These are:
- Financial accounting
- Managerial accounting
- Tax accounting
Firstly, managerial accounting deals with the strategic elements of company affairs and benefits internal stakeholders. On the other hand, financial accounting is a step ahead of bookkeeping and presents data in an understandable form to primarily external stakeholders. In practice, however, finance managers utilize tools from all branches of accounting without drawing clear distinctions between them.
For beginners in the field, this might be a question of specialization, though. In that sense, managerial accounting presents a perfect career path for individuals who wish to partake in the organization’s future strategy and business trajectory. Whereas financial accounting would be a good choice for financial analysts and future auditors.
|Managerial Accounting||Financial Accounting|
|Forward-looking||Looks to the past|
|Strategic insights||Analytical insights|
|For internal users||For external users|
|Incorporates financial and non-financial information||Only financial information is assessed|
|No audit required||Audited|
|No universally recognized standards||IAS, IFRS, US GAAP|
|Short-term insights||Long-term projections|
Managerial Accounting vs. Financial Accounting: Target Audience
Who is Managerial Accounting for?
Managerial accounting, as the name suggests, is primarily for the use of business managers and other internal stakeholders. One of its crucial functions is to keep expenses in check. This is important because costs are among the key growth drivers a business needs to analyze to be successful. Moreover, in increasingly competitive environments, even the slightest cost fluctuations can cause ripple effects down the supply chain. So, learning how to effectively manage costs and their impact on the company’s products is key to ruling the market.
Managerial Accounting Example
For example, the high-street fashion brands Primark and Monsoon are known for having similar designs. However, the prices offered to customers vary between the two retailers. Thus, a cotton jersey dress sells for $10 at Primark. Whereas the exact same design goes for $15 at Monsoon. For the moment, let us ignore the value of brand image and try to investigate this issue purely from the perspective of Cost of Goods Sold.
So, Primark sources its cotton from Pakistan and outsources the manufacturing to Pakistani factories. In contrast, Monsoon sources cotton from Pakistan but manufacturing is done in Bangladeshi factories. As a result, they have to pay significant freight charges. Both Pakistani and Bangladeshi manufacturers charge $5 for producing the dress. However, Monsoon incurs a shipping charge of $8 per dress for the cotton. Therefore, the exact same design and dress cost Monsoon $13 and Primark only $5. Primark makes a profit of $5 per dress, whereas Monsoon only makes a profit of $2 per dress.
For a finance manager at Monsoon, identifying this cost issue will be key to the company becoming more competitive. Through alternative suppliers they can bring down the cost of production. Once that is done, the same dress can be offered for $10 by Monsoon as well. Then, revenue generation and competition will hinge on brand image and customer loyalty alone.
Who is Financial Accounting for?
While managerial accounting serves to improve internal company operations, financial accounting has an altogether different purpose. It targets external stakeholders such as investors and banks and aims to present a comprehensive picture of an organization’s year-on-year performance.
Financial Accounting Example
For example, an investor is reviewing two companies’ stocks, both priced at $500. As part of their research, they attempt to find annual audited financials. Combining insights from the major financial statements of each company with valuation ratios analysis, they obtain the following picture:
|Specifics||Dairy Milk Chocolates Company||Mars Chocolates Company|
|Annual Sales||$10 Billion||$15 Billion||$10 Billion||$20 Billion|
|Annual Profits||$8 Billion||$10 Billion||$6 Billion||$4 Billion|
|Dividend Per Share||$100||$150||$60||$80|
So, they prepare the following year-on-year comparison:
|Comparison YoY (2020-2021)||Dairy Milk||Mars|
|Share Price Growth||11.11%||42.86%|
From here, the investor can decide what matters most to them: short-term share price appreciation or growth in dividends YoY. Then, if they are looking for share price appreciation, they would prefer to buy stock in Mars. Whereas, if they are interested in increasing dividends every year, they will choose Dairy Milk.
This is how financial accounting allows external stakeholders to make informed decisions about companies they are interested in.
Principles and Regulations
Importantly, financial accounting is regulated by two major bodies, FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board). Moreover, it must comply with the financial reporting standards issued by one or the other (depending on location) — US GAAP (FASB) and IAS and IFRS (IASB).
In contrast, managerial accounting is not governed by any regulatory body or mechanism. This gives companies freedom to use the concepts and methods that best fit their own needs instead of following a strict framework.
Managerial Accounting vs. Financial Accounting: Time Periods
Financial accounting looks at past data as a meaningful metric of company performance. Therefore, it is primarily focused on the financial past of companies. For example, year-on-year trends allow external stakeholders to build financial models of expected growth.
On the other hand, managerial accounting seeks to understand present data and set targets for the near future. Hence, it is more forward-looking in its effects. For instance, preparing the master budget and accounting for every possible expense in the next year based on data from the current period.
Financial accounting aggregates chunks of bookkeeping data in a concise manner. In contrast, managerial accounting’s insights often come in the shape of highly detailed, in-depth analyses of various cost functions.
For instance, managerial accountants are often tasked with reporting on overhead cost absorption. Thus they regularly have to present Activity Based Costing reports or Traditional Absorption Costing reports to managers using snippets of information from things such as electricity bills, payrolls, transportation charges, etc, dividing it into chunks and calculating cost rates. In other words, taking a smaller pool of data and adding value to it by making it more detailed for the end-user.
On the contrary, a financial accountant will often have to analyze company performance in a year-end profit and loss statement. That is, take a large data set and summarize it in a way that adds value to the end-user.
So, managerial accounting enables effective decision-making via expanding existing data. While financial accounting enables decision-making via summarizing existing data.
In essence, the accounting field is ever growing and diverse. As a result, each area of accounting offers a unique career path. Thus, if you prefer a more multifaceted role in a fast-paced environment, managerial accounting has a plethora of benefits. For example, working in a startup finance team with new challenges at every corner.
Whereas if you prefer a more integrated, yet analytical role, financial accounting is just right for you. So, as a financial accountant you could be preparing audit reports at one of the Big 4 audit firms or working at an investment bank.
More often than not, distinctions such as financial vs. managerial accounting are blurred in business practice. For instance, budget preparation entails using financial accounting tools to drive managerial accounting decisions. In fact, the more you grow in your finance career, the less likely you are to draw clear lines between these different types of accounting. When you reach the stage of finance manager, you will be expected to have mastered not just managerial and financial accounting, but also capital budgeting techniques, effective presentation and negotiation skills, in-depth knowledge of Excel and more. With our Complete Finance Manager Course you will gain the skills you need to reach your desired role.
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