Difference Between Financial and Managerial Accounting

Accounting is a crucial function in any business, helping managers make key financial decisions and comply with reporting requirements. There are two main branches of accounting – financial accounting and managerial accounting. While both analyze financial transactions, they have different end users and serve different purposes.

Financial accounting focuses on preparing external financial statements to provide information to shareholders, creditors, regulators and the public. Managerial accounting deals with internal financial information used by management to operate the business on a day-to-day basis.

This article will explore the key differences between these two types of accounting and why both are vital for an organization’s success.

What is Financial Accounting?

Financial accounting refers to the process of recording, summarizing, and reporting the transactions and financial statements of a business to external users. The key aspects of financial accounting include:

• It deals with the preparation of general purpose financial statements such as the income statement, balance sheet, statement of cash flows and statement of retained earnings.
• The primary objective of financial accounting is to provide information about the overall financial performance and position of the company to external stakeholders like investors, creditors, regulators, etc.
• It must follow Generally Accepted Accounting Principles (GAAP) and standards set by regulatory bodies like the Financial Accounting Standards Board (FASB). This ensures the comparability of financial statements across different companies.

Principles of Financial Accounting

The four main principles of financial accounting are objectivity, matching, revenue recognition, and consistency. Objectivity means accounting information is supported by evidence and free from bias. The matching principle states expenses should be matched with related revenues in the same reporting period. Revenue recognition involves identifying when revenue has been earned and should be recorded. Finally, consistency refers to the use of consistent accounting methods from period to period to allow for comparability. Together, these principles aim to provide reliable, relevant, and comparable financial information about a company’s performance and position over time.

Example

When a publicly-traded company like Apple Inc. releases its quarterly financial statements to investors and financial analysts, it provides a comprehensive overview of its revenue, expenses, assets, and liabilities. These statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP) to ensure transparency and comparability across companies.

What is Managerial Accounting?

Managerial accounting involves the internal identification, measurement, analysis and communication of financial information needed by management to plan, evaluate and control operations within an organization. The key aspects include:

• It deals with the preparation of detailed, customized reports tailored to the specific needs of different levels of management to support planning and controlling of operations.
• The main purpose of managerial accounting is to provide information to managers to assist in decision making related to optimizing efficiency, productivity and profitability.
• It is not bound by GAAP or IFRS. Internal reporting can be formatted as needed by managers.

Principles of Managerial Accounting

Managerial accounting focuses on providing forward-looking, relevant information to help managers make decisions and improve efficiency. It emphasizes analysis of segments of the business, flexibility in reporting, use of both financial and non-financial data, and a focus on incremental costs and profits. Rather than just capturing historical costs, managerial accounting tailors analysis and recommendations to the specific needs of managers to aid planning, directing, and controlling operations. The goal is to provide managers with the most relevant information and tools to make informed decisions that will improve operations and profitability.

Example

Suppose a manufacturing company wants to introduce a new product line. Managerial accountants would analyze the potential costs, revenues, and profitability of the new product, considering factors such as production costs, market demand, and pricing strategies. Based on this analysis, management can decide whether to proceed with the new product launch.

Comparison Chart

Financial and managerial accounting are similar in that both involve the use of financial data for decision-making processes within an organization. However, there are still major differences between when undergoing managerial accounting vs financial accounting. These are listed below:

Financial Accounting vs Managerial Accounting – Key Differences

Reporting Focus

Financial accounting focuses on producing general purpose financial statements (balance sheet, income statement, statement of cash flows) at the end of reporting periods to provide information about the overall financial performance and position of a company to external stakeholders like investors, lenders, regulators etc.

Managerial accounting, on the other hand, has an internal focus, producing detailed reports, analyses and information to help managers within the organization make decisions related to planning, directing and controlling operations. These reports are tailored to the specific needs of management.

Rules & Regulations

Financial accounting follows statutory rules and regulations like GAAP or IFRS. The objective is to ensure standardization and comparability of financial statements.

In contrast, managerial accounting does not need to follow GAAP or IFRS. It has greater flexibility in terms of formatting reports and using different costing methods or estimations based on management needs.

Time Horizon

Financial accounting provides information on past performance over accounting periods. It is historical in nature.

Managerial accounting is more forward-looking, providing information like budgets and forecasts to help plan future operations.

Level of Detail

Financial accounting looks at the organization as a whole, consolidating information and recording summarized transactions.

On the other side, managerial accounting goes into greater detail, providing segmented information for specific products, departments, projects etc. to aid in decision making.

Audience

Financial accounting serves the information needs of external stakeholders like shareholders, creditors, tax authorities, government agencies.

Comparing to above, managerial accounting furnishes internal management of the organization, providing information to managers to assist in planning, directing, motivating and performance evaluation.

Systems

Financial accounting focuses on reporting profitability and the overall financial position of the organization. It tracks revenue, expenses, assets and liabilities through the general ledger system.

Similarly, managerial accounting identifies issues within the organization’s operations that affect profitability. It provides detailed reports to help managers address inefficiencies in production, marketing, HR and other areas to enhance profits.

Efficiency Analysis

Financial accounting reports on the overall profitability and return on investment for the company as a whole. It provides insights into the financial health of the organization and its performance over a specific period. However, it typically does not jump to the granular details of operational efficiency within the business.

In contrary, managerial accounting does in-depth analysis on operating efficiency for specific products, departments, regions etc. It reports on problem areas and provides recommendations to improve efficiency.

Timing of Reporting

Financial accounting follows a structured schedule, producing standardized reports at the end of quarterly and annual accounting periods. This periodicity ensures consistency and accuracy in financial reporting practices, facilitating comparability across time periods.

In contrast, managerial accounting offers flexibility in timing. Reports can be generated monthly, weekly, or even daily, depending on the information needs of management. This adaptability allows for timely access to relevant data, enabling management to make informed decisions and respond promptly to changing business conditions.

Proven data vs. Estimates

Financial accounting relies on verifiable, proven data from actual transactions and events. Estimates are minimally used.

Conversely, managerial accounting frequently relies on forecasting and estimates in areas like budget preparation. Historical data is used in conjunction with projections.

Standards

Financial accounting must comply with either Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). These standards ensure consistency and comparability in financial reporting across companies, facilitating transparency for external stakeholders.

In contrast, managerial accounting is not required to follow GAAP or IFRS. Management has the freedom to design reporting formats tailored to internal needs, allowing for flexible analysis and decision-making support within the organization.

Valuation

In financial accounting, assets and liabilities are valued according to accounting standards mandated for reporting on the balance sheet. This ensures conformity and accuracy in presenting the financial position of the company to external stakeholders.

Conversely, managerial accounting delves deeper into the analysis of assets and liabilities, considering their impact on productivity, efficiency, and costs within the organization. The focus extends beyond mere monetary value to encompass operational implications, aiding management in making informed decisions to optimize resources.

Certification and Training

Professionals in both financial and managerial accounting often undergo specialized training and certification programs to enhance their skills and credibility in the field. Financial accountants typically pursue certifications such as the Certified Public Accountant (CPA) designation, equipping them with the expertise to handle complex financial reporting requirements and ensure compliance with regulatory standards. In contrast, managerial accountants may opt for the Certified Management Accountant (CMA) designation, which focuses on managerial decision-making, strategic planning, and performance management within organizations.

Final Words

While financial accounting focuses on producing standardized financial statements for external stakeholders to ensure transparency and comparability, managerial accounting plays a crucial role in providing detailed, internal information tailored to the specific needs of management for decision-making and operational control.

Both branches of accounting are essential for the success of an organization, working hand in hand to provide a comprehensive view of the financial health and operational efficiency. By integrating the insights from both financial and managerial accounting, businesses can make informed decisions, optimize performance, and drive sustainable growth in today’s dynamic and competitive business environment.

NEIL DUNCAN

Neil Duncan, a professional in business innovation and management, has a deep interest in writing and sharing his voice by publishing articles on different b2b and b2c websites/blogs like this. He currently serves as the Vice President in AZ.