What Is Difference Between Financial Accounting and Management Accounting?

Financial Accounting is a form of accounting that involves analyzing, summarizing, and documenting day-to-day business transactions, and compiling books of accounts to evaluate the company’s financial health & performance during a financial period, and presenting a true & fair picture of the company’s operations to external stakeholders such as investors, creditors, and regulatory authorities.

When it comes to financial accounting, there is a set of guidelines to be followed, known as Generally Accepted Accounting Principles (GAAP). By adopting these guidelines, companies maintain uniformity and standardization across their accounting process and gain credibility from external stakeholders. Indian companies use a double-entry bookkeeping system where each transaction is recorded twice – both on the Debit (Dr) and Credit (Cr) side.

Importance of Financial Accounting

As we’ve already covered what is financial accounting, let us discuss why financial accounting is so important and why companies have to maintain books of accounts throughout every financial year.

1. Financial Transparency

The purpose of financial accounting reports is to provide a clear understanding of the company’s financial condition to different stakeholders. A business can automate and set accounting standards with a?finance module in ERP?to maintain financial transparency and reporting consistency.

2. Prevents Frauds

As per our financial accounting meaning, maintaining financial records allows you to identify reporting errors. Automating financial reporting helps streamline your accounting process, eliminate spreadsheet sprawls, and minimize reporting mistakes.

3. Regulatory Compliance

Regulatory bodies, like the Income Tax Department, access a company’s profit loss statements to check income tax payment status. You can avoid trouble with government agencies by maintaining transparent and up-to-date financial records.

4. Strategy Building

Cash flow statement, and financial accounting statements (such as Profit & Loss reports and Balance Sheet) are good starting points for strategy development. These allow you to look closely at your financial performance metrics —revenue earnings, operational costs, sales volume, debt, etc.

5. Gain Investor Confidence

Financial accounting provides comprehensive information about the financial health and performance of the company, including its growth prospects. It instills trust in the minds of prospective investors who are looking to invest in the company and contribute to its growth story.

What is Management Accounting?

Management Accounting is a form of accounting that involves the creation of accounting statements and reports through the analysis of quantitative and qualitative measures, for the purpose of guiding higher management with planning, forecasting, organizing and directing operations, and accomplishing long-term goals.

Management accounting primarily deals with product costing, marginal analysis, capital budgeting, trend analysis, project appraisal, and constraint analysis. The purpose of management accounting is to assist the higher management in informed decision-making for revenue generation and eliminating inconsistencies.

Importance of Management Accounting

Now that we’ve covered management accounting meaning, let us understand its importance and how it supports higher management in decision-making.

1. Strategic Planning

The primary objective of management accounting reports is to provide data for discussions and decision-making. These capture historical data, like information on business growth, which aids in forecasting.

2. Qualitative Information

As per what we already discussed under what is management accounting, its scope also includes analyzing qualitative data for a holistic overview to aid decision-making. Management accounting reports include qualitative information like industry cycles and R&D activities useful for strategy development.

3. Help Achieve Goals

Management accounting collects and analyzes financial data from different sources and presents it in a way that is easier for the management to understand. Insights from the reports help in budget control, cost cutting, and improving the company’s financial health.

4. Optimize Resource Usage

Management accounting enables the management to perform activity-based costing, identify the areas of business operations that need improvement, and make efficient use of the organizational resources (whether cash, fixed assets, or human resources). Efficient use of the resources directly translates into higher productivity and enhanced efficiency.

5. Identify Cost-saving Opportunities

Decision-makers use the best ERP software in India for management accounting and assessing the cost implications of the potential decisions, and taking appropriate cost-control measures. For instance, they may use robust inventory management software to save inventory storage costs & prevent additional costs & loss of revenue arising from over-stocking/ under-stocking.

Difference Between Financial Accounting and Management Accounting

After exploring financial accounting meaning and management accounting meaning, let’s delve into the difference between financial accounting and management accounting?to get more clarity about each.

Financial accounting and management accounting differ in their purposes. While financial accounting communicates the financial performance of a business to investors, creditors, or regulators, management accounting is an internal document that aids the management in the decision-making process.

Similarities Between Financial Accounting and Management Accounting

After understanding the difference between financial accounting and management accounting, it’s equally crucial to discuss the similarities between the two.

1. Horizontal Analysis

Both Financial Accounting and Management Accounting emphasize horizontal analysis to understand the financial changes in the company over a specific period of time. Horizontal analysis accompanied by trend analysis helps decision-makers with timely & accurate decision-making, and gain an understanding of the company’s profitability.

2. Vertical Analysis

Vertical Analysis involves breaking down financial statements into individual components where each line item indicates the percentage of the base figure. In vertical analysis, each data point is the fraction of the revenue generated from total sales. Both financial accounting and management accounting emphasize it.

3. Analytical Techniques

Ratio Analysis and Regression Analysis are extensively used in both financial accounting and management accounting. However, the purpose of ratio analysis is different. Financial accounting uses ratio analysis to evaluate the company’s financial health & performance whereas management accounting uses it to find new ways to increase the operational efficiency of the company.

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