I always like to explain complicated abstract concepts in a more systematic way. One of my favourite masters of management and leadership is Peter Dructer. He always explains the abstract concept in a rational way. One of his famous “5 important questions” can be used to explain the differences. Peter Drucker emphasises the sequences of the 5 important questions:
- What’s the Purpose?
- Who are the Audiences?
- What’s the Values?
- How to Measure the impact?
- What is the Execution plan?
Let’s define the PURPOSE of Financial accounting and Managerial accounting first.
What is financial accounting?
Well, let’s take a look at a simple definition: Financial account is a series of processes of summarising, recording and analysing a corporation’s financial transactions and representing the results in financial statements to its stakeholders like investors, management or creditors.
How about managerial accounting?
Simply speaking, it’s all about managerial decision making. Thus the definition should be: Managerial accounting is the series of processes for measuring, identifying and communicating accounting information to the management team so that they can make decisions or plan or avoid the risk of a corporation.
Now you basically understand why both of them exist, and they are just sub-branches of accounting, there are still lots of branches like talking about bookkeeping, taxes, auditing, etc. Next we will explore the target audiences of these terms.
Who are the target audiences of Financial accounting?
As stated in the definition, financial accounting is the expression of the “financial health” toward the investors. Thus EXTERNAL parties are the target audiences. Those parties out of the company can basically understand the financial status of a particular company with the financial statements like balance sheet, income statement, statement of cash flow, profit and loss, etc. For example, professional stock investors will go deep into the financial statements to reveal if the stock is worth to invest; you will look at the details of the financial statement for an Ecommerce business before you purchase the website.
Who are the target audiences of Managerial accounting?
Managerial accounting literally helps business’s managers make decisions according to the reports and the data. Thus the target audiences are INTERNAL parties. Management team should make a better decision with the accounting data provided and plan for the future. For example, product costing and valuation help managers understand the total cost of producing the services or the goods, the cash flow analyst helps the management team make decisions if there is enough cash flow to purchase some new equipment; Constraint analysis can help identify what kinds of constraints are available as a bottleneck to the production line so as to calculate the impact of cost and revenue in the long run. So all of these help to manage the profitability and performance of a corporation so as to reduce the risk taking by the entities.
What are the values of Financial accounting and Managerial accounting?
Up to now, I guess you get the differences between the two accounting branches. Let’s talk more about the values. As mentioned, financial accounting targets the investors and outside observers, they are looking for a big picture of the company in the PAST, like is the company keeping to earn money or lose money? Is the company’s cash flow healthy? Should I invest in the company at all? Those questions are the key response of financial accounting. To be honest, the investors don’t even care about the detailed cost of the company’s stationery or the insurance or retirement benefits of individual staff.
For managerial accounting, the details and timeliness matter. Why? As a manager, you make decisions with the timely information, for example, the price of the raw materials in July will be different compared to August, so the price analyst in July required up to date information for decision making of a production line. Manager will make decisions for the FUTURE with the managerial accounting reports.
In short, financial accounting concerns the past statements while managerial accounting assists the manager for the future decisions.
How to measure and execute the financial accounting and managerial accounting?
Talking about the measurement and execution of financial accounting and managerial accounting, they are similar but can be completely different. The main reason is the nature of the branches. As keep on emphasis, financial accounting targets external investors, the terminology used and the accounting methods used are governed by the standard.
For example, you can check the International Financial Reporting Standards (IFRS) website, which is an institute providing training and education to the members like CPA, professional accountants, etc. You can’t just do whatever you want under financial accounting like income statements, balance sheets and statements of stockholders’ equity, which have regular rules.
However, for managerial accounting, more “FREE STYLE” or more adoption in a company’s own style are allowed as the reports or information are for management team making decisions only. Managerial accountants can even use lots of shortcut and personalise methodologies to deliver the decision making reports once it’s accurate and timely enough to allow different internal stakeholders to make the decisions.
