If you’ve always thought that managerial accounting, sometimes referred to as management accounting, and financial accounting were the same, you may be in for a surprise.
While both deal with numbers, that’s where many of the similarities end. Read on as we take a dive into accounting 101 and explore exactly what each is, where they differ, and where they’re similar.
Here are the differences between financial and managerial accounting:
- Managerial accounting is used strictly for internal purposes, while financial accounting provides financial information based on accounting standards.
- Managerial accounting frequently looks ahead, while financial accounting offers analysis of historical data.
- Managerial accounting typically runs a variety of operational reports throughout the month, while financial accounting runs financial statements at the end of the accounting period.
- Managerial accounting uses estimated amounts, while financial accounting only uses actual numbers.
If you’re training your employees how to track business expenses more efficiently, you’re using managerial accounting, but if you’re using accounting ratios to determine the profitability of your company, you’re using financial accounting.
What is managerial accounting?
Managerial accounting centers around managing the internal needs of a business. For instance, Frank, your top salesman, notifies you that one of his customers is closing down at the end of the year.
Since Frank’s customer brings in a lot of revenue, you need to devise a plan that will help to offset that loss. However, when you review your financial statements for the past six months, you see that revenue is down across the board. The following day, you and your staff create a plan for bringing in more revenue, starting with expanding sales territories.
During this staff planning session, you create a training plan for getting newer sales people up to speed, while also estimating the amount of new revenue needed to make up for the expected loss next year. That’s managerial accounting.
Because managerial accounting centers around business potential and performance, it mainly deals with the future.
Like the example above, managerial accounting focuses on problem solving, devising strategies for making the company more profitable and efficient long term.
Financial accounting does play a role in managerial accounting, mainly in the form of financial statements, which are necessary when creating strategic plans, streamlining operations, solving logjams, and creating budgets and forecasts.
What is financial accounting?
While the focus of managerial accounting is internal, the focus of financial accounting is external, with a focus on creating accurate financial statements that can be shared outside the company.
For any public company, financial accounting processes must abide by a very specific set of rules provided by the Generally Accepted Accounting Principles (GAAP), the accounting standard adopted by the U.S. Securities and Exchange Commission framework.
There are also additional rules for publicly held companies that are governed by the Securities and Exchange Commission (SEC) that need to be followed as well.
Financial accounting uses a chart of accounts that has been created for the company, with set policies and procedures in place that govern how transactions are to be posted using these accounts, with the end goal to create factual financial statements for a very specific period of time.
However, it’s important to remember that routine tasks such as creating an invoice or tracking accounts receivable balances are also part of the financial accounting process.
As I mentioned earlier, though financial accounting is frequently used alongside managerial accounting, its main purpose is to disclose the financial health of a business to interested third parties such as financial institutes, investors, and industry officials.
Think of it like this: managerial accounting is used by management to better run the company, while financial accounting is used by third parties to determine compliance standards set by the Financial Accounting Standards Board (FASB) and other regulators.
How managerial and financial accounting differ
Both managerial accounting and financial accounting are centered around numbers, but how those numbers are used varies greatly in these two accounting methods.
|Managerial Accounting||Financial Accounting|
|Used internally||Used externally|
|Looks ahead||Looks at historical performance|
|Looks at operational and financial data||Only looks at financial data|
|Focuses on specific management needs||Reports on the entire company|
|Managers can choose the information they need||Information is provided based on outside regulators|
Managerial accounting looks at a way to solve specific management issues while financial accounting looks at the company as a whole.
1. Looking forward vs. looking back
Financial activity is handled very differently in managerial and financial accounting. Managerial accounting is used to create strategic plans, tasking managers with creating budgets, and estimating upcoming income and expenses.
Financial accounting analyzes company results that have already been achieved, with those results contained in financial statements.
2. Reporting focus is different
Reporting is handled very differently in managerial and financial accounting. In managerial accounting, reports are run much more frequently and tend to focus on day-to-day operations.
Financial accounting focuses on performance for a very specific time frame. Another major difference is that managerial reports are used internally, while financial reports are distributed to those outside the company, including regulators, investors, and financial institutions.
|Managerial Reports||Financial Reports|
|Departmental reports||Balance sheet|
|Sales reports||Income statement|
|Inventory reports||Cash flow statement|
3. Estimates vs. facts
If you’ve ever sat in on a budget meeting, you know that the numbers in a budget can be quite arbitrary. And while financial statements are frequently used as a starting point for creating a budget, budget estimates are usually created based on the needs and expectations of the manager(s) that are creating that budget. Financial statements are completely different.
The information contained in financial statements must be accurate and is derived from the various financial transactions entered throughout the specified accounting period.
Remember, the facts contained in financial statements often play a role in managerial accounting, but estimates have no role in financial accounting.
4. Legal requirements
There are no legal standards or requirements involved with managerial accounting, which can be used by businesses as they wish.
However, any publicly traded company is required to prepare financial statements that follow set rules and regulations.
While many businesses use a combination of managerial and financial accounting, only the financial statements produced using financial accounting processes are required to be audited by an independent CPA firm.
While you’re likely using accounting software in order to track your financial accounting activity accurately, you’ll probably need to use other resources such as budgeting or planning tools in managerial accounting.
How managerial and financial accounting are similar
Managerial accounting and financial accounting do have a few things in common. Both need to have accurate numbers to work from: managerial accounting to use as a basis for creating budgets and estimates, financial accounting to comply with FASB standards in order to be deemed accurate and in compliance with regulations.
While managerial accounting works more as a problem solver, financial accounting shows you exactly what your business has accomplished to date.
In most companies, they are used simultaneously to create a more efficient, profitable business.
Though some accounting software applications do offer budgeting capability, many businesses use a spreadsheet application such as Microsoft Excel to create budgets and estimates.
Managerial accounting and financial accounting are stronger together
While it’s certainly possible for a business to use only financial accounting, putting managerial accounting into the mix will provide businesses with the best of both worlds: accurate financial statements and a way to plan for a brighter future.
Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool owns shares of and recommends Intuit and Microsoft. The Motley Fool owns shares of Xero and recommends the following options: long January 2021 $85 calls on Microsoft. The Motley Fool has a disclosure policy.