Many business owners are not aware that there are two types of accounting: financial accounting and management accounting.
Both types of accounting are necessary for a company to operate efficiently and effectively and both help to maximize the potential of the company.
The Low Down on Financial Accounting
Financial accounting is used to present your financial statements to external users, such as shareholders, the CRA and other regulators, lenders, employees, or suppliers. Financial statements are prepared according to guidelines set by CPA Canada or an international body. Financial statements can include:
- The Balance Sheet, which shows your business’s assets and liabilities at a point in time
- The Income Statement (also referred to as Statement of Earnings or Profit and Loss Statement), which shows your company’s profit and loss over a specific time
- The Cash Flow Statement, which shows how a business generates and spends its earnings
- Notes to the financial statements, which provide additional details on certain account balances and accounting procedures that the company has followed throughout the period
What’s Up with Management Accounting
Management accounting is an internal source of information for you, the business owner, to use. There’s no need to follow set guidelines. You and your accountant determine the kind of information you require to make business decisions and then your accountant figures out the formulas and processes needed to get that information to you.
Management accounting might include analyzing the profitability of different business segments or analyzing the effect of certain decisions on profits. It involves a lot of analysis and it’s all done to give the business owner the information required to make strong decisions that will positively impact the business.
The Problem With Financial Accounting
Although financial reporting is a requirement for all businesses, the statements are not usually the best source of information by which to make business decisions. For example:
- The Income Statement typically shows expenditures as cost of sales and expenses, and business owners often rely on these numbers to make future decisions. Another useful way to use expenses as performance indicators is to separate them into fixed costs and variable costs. Fixed costs are those that must be paid regardless of sales volume, while variable costs are directly related to the level of sales. Understanding the relationship of sales, fixed costs, and variable costs will allow you to make more informed pricing and other decisions.
- It is a common misconception that net income (or net profit) equals cash in the bank. This misconception invariably leads to cash flow problems. Cash is affected by net income, but also by changes in working capital (accounts receivable, accounts payable, etc.) debt payments, payments for capital items, etc.
The Problem with Management Accounting
The big problem with management accounting is that it’s not a requirement, so few business owners know what information is needed to make good business decisions or how to prepare effective information. After all, why spend time and money on something you don’t need?
Here’s the thing: you do need it. Financial accounting is great for keeping you in compliance and ensuring you keep as much of your profits as possible from a tax perspective. But it’s not nearly as effective as management accounting when it comes to making business decisions. The information you need to make business decisions that will result in growth and increased success is highlighted and enhanced by using management accounting.
We provide management accounting services as an integral part of our Unburdened package because we want to see our clients’ businesses grow and growth only happens if they’re making decisions based on good information and metrics. If you’re not getting the information you need from your accountant, talk to him or her about management accounting services. It can make an enormous difference in your business’s success.