Managerial Accounting

What Is Managerial Accounting?

Managerial accounting is the practice of identifying, measuring, analysing,
interpreting, and communicating financial information to managers for the pursuit
of an organization's goals. It varies from financial accounting because the
intended purpose of managerial accounting is to assist users internal to the
company in making well-informed business decisions.

How Managerial Accounting Works

Managerial accounting encompasses many facets of accounting aimed at
improving the quality of information delivered to management about business
operation metrics. Managerial accountants use information relating to the cost
and sales revenue of goods and services generated by the company. Cost
accounting is a large subset of managerial accounting that specifically focuses
on capturing a company's total costs of production by assessing the variable
costs of each step of production, as well as fixed costs. It allows businesses to
identify and reduce unnecessary spending and maximize profits.

Managerial Accounting vs. Financial Accounting

The key difference between managerial accounting and financial accounting
relates to the intended users of the information. Managerial accounting
information is aimed at helping managers within the organization make well-
informed business decisions, while financial accounting is aimed at providing
financial information to parties outside the organization.

Financial accounting must conform to certain standards, such as generally

accepted accounting principles (GAAP). All publicly held companies are required
to complete their financial statements in accordance with GAAP as a requisite for
maintaining their publicly traded status.1  most other companies in the U.S.
conform to GAAP in order to meet debt covenants often required by financial
institutions offering lines of credit.

Because managerial accounting is not for external users, it can be modified to

meet the needs of its intended users. This may vary considerably by company or
even by department within a company. For example, managers in the production
department may want to see their financial information displayed as a percentage
of units produced in the period. The HR department manager may be interested
in seeing a graph of salaries by employee over a period of time. Managerial
accounting is able to meet the needs of both departments by offering information
in whatever format is most beneficial to that specific need.
KEY TAKEAWAYS

 Managerial accounting involves the presentation of financial information for

internal purposes to be used by management in making key business
decisions.
 Techniques used by managerial accountants are not dictated by
accounting standards, unlike financial accounting.
 The presentation of managerial accounting data can be modified to meet
the specific needs of its end-user.
 Managerial accounting encompasses many facets of accounting, including
product costing, budgeting, forecasting, and various financial analysis.

Types of Managerial Accounting

Product Costing and Valuation

Product costing deals with determining the total costs involved in the production
of a good or service. Costs may be broken down into subcategories, such as
variable, fixed, direct, or indirect costs. Cost accounting is used to measure and
identify those costs, in addition to assigning overhead to each type of product
created by the company.

Managerial accountants calculate and allocate overhead charges to assess the

full expense related to the production of a good. The overhead expenses may be
allocated based on the number of goods produced or other activity drivers related
to production, such as the square footage of the facility. In conjunction with
overhead costs, managerial accountants use direct costs to properly value the
cost of goods sold and inventory that may be in different stages of production.

Marginal costing (sometimes called cost-volume-profit analysis) is the impact on

the cost of a product by adding one additional unit into production. It is useful for
short-term economic decisions. The contribution margin of a specific product is
its impact on the overall profit of the company. Margin analysis flows into break-
even analysis, which involves calculating the contribution margin on the sales
mix to determine the unit volume at which the business’s gross sales equal total
expenses. Break-even point analysis is useful for determining price points for
products and services.

Cash Flow Analysis

Managerial accountants perform cash flow analysis in order to determine the
cash impact of business decisions. Most companies record their financial
information on the accrual basis of accounting. Although accrual accounting
provides a more accurate picture of a company's true financial position, it also
makes it harder to see the true cash impact of a single financial transaction. A
managerial accountant may implement working capital management strategies in
order to optimize cash flow and ensure the company has enough liquid assets to
cover short-term obligations.

When a managerial accountant performs cash flow analysis, he will consider the
cash inflow or outflow generated as a result of a specific business decision. For
example, if a department manager is considering purchasing a company vehicle,
he may have the option to either buy the vehicle outright or get a loan. A
managerial accountant may run different scenarios by the department manager
depicting the cash outlay required to purchase outright upfront versus the cash
outlay over time with a loan at various interest rates.

Inventory Turnover Analysis

Inventory turnover is a calculation of how many times a company has sold and
replaced inventory in a given time period. Calculating inventory turnover can help
businesses make better decisions on pricing, manufacturing, marketing, and
purchasing new inventory. A managerial accountant may identify the carrying
cost of inventory, which is the amount of expense a company incurs to store
unsold items. If the company is carrying an excessive amount of inventory, there
could be efficiency improvements made to reduce storage costs and free up cash
flow for other business purposes.

Constraint Analysis
Managerial accounting also involves reviewing the constraints within a production
line or sales process. Managerial accountants help determine where bottlenecks
occur and calculate the impact of these constraints on revenue, profit, and cash
flow. Managers can then use this information to implement changes and improve
efficiencies in the production or sales process.

Financial Leverage Metrics

Financial leverage refers to a company's use of borrowed capital in order to
acquire assets and increase its return on investments. Through balance
sheet analysis, managerial accountants can provide management with the tools
they need to study the company's debt and equity mix in order to put leverage to
its most optimal use. Performance measures such as return on equity, debt to
equity, and return on invested capital help management identify key information
about borrowed capital, prior to relaying these statistics to outside sources. It is
important for management to review ratios and statistics regularly to be able to
appropriately answer questions from its board of directors, investors, and
creditors.
Accounts Receivable (AR) Management
Appropriately managing accounts receivable (AR) can have positive effects on a
company's bottom line. An accounts receivable aging report categorizes AR
invoices by the length of time they have been outstanding. For example, an AR
aging report may list all outstanding receivables less than 30 days, 30 to 60 days,
60 to 90 days, and 90+ days. Through a review of outstanding receivables,
managerial accountants can indicate to appropriate department managers if
certain customers are becoming credit risks. If a customer routinely pays late,
management may reconsider doing any future business on credit with that
customer.

Budgeting, Trend Analysis, and Forecasting

Budgets are extensively used as a quantitative expression of the company's plan
of operation. Managerial accountants utilize performance reports to note
deviations of actual results from budgets. The positive or negative deviations
from a budget also referred to as budget-to-actual variances, are analysed in
order to make appropriate changes going forward.

Managerial accountants analyse and relay information related to capital

expenditure decisions. This includes the use of standard capital budgeting
metrics, such as net present value and internal rate of return, to assist decision-
makers on whether to embark on capital-intensive projects or purchases.
Managerial accounting involves examining proposals, deciding if the products or
services are needed, and finding the appropriate way to finance the purchase. It
also outlines payback periods so management is able to anticipate future
economic benefits.

Managerial accounting also involves reviewing the trend line for certain expenses
and investigating unusual variances or deviations. It is important to review this
information regularly because expenses that vary considerably from what is
typically expected are commonly questioned during external financial audits. This
field of accounting also utilizes previous period information to calculate and
project future financial information. This may include the use of historical pricing,
sales volumes, geographical locations, customer tendencies, or financial
information.