Making financial decisions within a business can be tough. To make it a bit easier, it’s common to delineate your accounting into two forms: financial accounting and managerial accounting.
In short, financial accounting focuses on numbers that should be presented to those outside of your business, while managerial accounting is used internally.
Let’s delve into the difference of these two forms of accounting. Check out the attached video, as well as our transcription of the video, and additional commentary below!
What’s the Difference Between Managerial and Financial Accounting?
“In this quick video, we’re gonna focus on the differences between financial and managerial accounting. If you’ve studied the subject of accounting at any length, you know that there are two different methods of accounting, and each of those has a different purpose and provides information for different individuals.
Financial Accounting for External Stakeholders
To start us off, let’s focus on financial accounting and really who it’s meant to provide information for and how it provides information. Now, financial accounting is primarily built and developed for the needs of external stakeholders. If you’re familiar with the concept of a stakeholder, a stakeholder is someone who has an interest in how the company operates and performs. So these could be anyone from investors to government agencies like the SEC.
Now because of the fact that they’re external, the key distinction here is that they do not work for the company and so these are outsiders. Although they are outsiders, they still have an interest in how the company operates. Now because these people are outside of the organization, they have different needs than someone who works inside the company. Because of that, there’s different types of information that’s provided.
As an external stakeholder, you’re not necessarily interested in very specific reports on budgets for individual departments or payroll costs within a specific unit. You really want to look at things on a kind of a macro scale. Kind of overall, and because of that, the information is going to be provided in the form of financial statements.
Those common financial statements can include a balance sheet, which is an account of the assets, liabilities, and equity within a company. They can take the form of an income statement, which is one of the more important statements that reflects the profitability of a firm. They can be a statement of cash flows, which is going to show the sources of cash in terms of where that cash is coming from, but also where it’s being spent. And it could also include a number of different statements, but these are the big three produced under financial accounting now.
Because we’re focusing on external stakeholders, there are certain provisions in place that dictate how those statements are created, if you will, and the reason for that is we want there to be some consistency. If you’re looking at an income statement from one company you want to have some assurances that it is created in a similar manner to a statement from a competitor, so that you can do some kind of comparative analysis between the two. Because of that, the financial accounting is governed by what we call generally accepted accounting principles commonly referred to simply as GAAP.
These are standards that are put in place for companies that produce documents for external stakeholders, where they have to follow certain guidelines. These include providing relevant information, providing accurate information, and then providing information that’s consistent over a period of time. If a company utilizes one method of accounting for inventory, like last in first-out or first-in first-out, it continues to utilize that method of accounting for inventory and doesn’t change every quarter which as you would know makes it very difficult for an investor to make an accurate comparison between one quarter from the next. That is a very important attribute of financial accounting, is this element of GAAP.
Managerial Accounting for Internal Stakeholders
Now managerial accounting is a little bit different. Where financial accounting focuses on the needs of external stakeholders, managerial accounting is going to focus on the needs of internal stakeholders. Now stakeholders being a consistent term between the two, is still someone who has an interest in how the company operates in some way, the performance of that company But because their internal, we’re focusing on people within the organization.
This can include business managers that need to make decisions, company executives, and even employees who are making decisions. They too have a need for relevant accounting information.
Now with managerial accounting, it’s much different than financial accounting because this is meant for internal stakeholders. They are not required to follow any exact reporting standards similar to generally accepted accounting principles, and that’s because nobody outside of the organization is meant to see this information. It is built for the people that need to make decisions with that information, so this can include a number of different things.
In terms of the distinction between the two, it can look at costs within a business unit, so if you’re looking specifically at, let’s say production costs within a product line, can look at payroll costs. I mean really the number of possible alternatives is almost limitless, and it really is at the discretion of the manager to request what kind of information that they need.
Now one key distinction here between these two, is that external financial accounting is primarily past looking, meaning it’s reporting what has already taken place. That is really commonality, because you’ve got these balance sheets and an income statements and statement of cash flows that are reporting what has already happened.
With managerial accounting, we are looking to the future. We’re trying to do projections to assess what could be the impact of a certain decision on a product line. If we decide to maybe maintain a piece of equipment versus replace it, what are the expected cash flows or what’s the implication on productivity. It is very much so individualized, and again it’s not intended for people outside of the organization. Now Financial Accounting plays a huge role in the planning process that takes place within businesses, and that’s a really important element. Managerial accounting rather is this planning aspect that business owners need access to this information to make profitable business decisions.”
Using Financial and Managerial Accounting in Your Business
Now that you know the difference between managerial and financial accounting, make sure to implement both in your business! Keeping separate accounting documents can help you to improve your business, while maintaining the necessities for any regulations you may have to uphold.
Have any interesting tips for financial or managerial accounting? Let us know about them below!