What is Financial 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.
| Financial Accounting | Management Accounting | |
| Definition | Financial accounting refers to recording, summarizing, and reporting myriad business transactions over a period. | Management accounting tracks operational details in a specific way to glean insights to aid budgeting, cost cutting, forecasting sales figures, or managing cash flow. |
| Objective | To communicate the financial performance, like profit and loss, to different stakeholders. | To aid management in planning strategies by delivering details on various metrics. |
| Application | To maintain financial transparency and provide a fair picture of the company’s financial performance. | For strategy planning and decision-making. |
| Reporting focus | Internal (management and employees) and external audiences like investors, creditors, regulators | The management, for internal decision-making purposes. |
| Time-frame | Due at the end of the accounting period – monthly, quarterly, or yearly. | Prepared according to the need. |
| Systems | Gather profit or revenue information | Provides details on operational bottlenecks and analyzes information to enhance profit |
| Aggregation | Look at overall organizational performance | Focus on detailed reports on specific processes such as product profit, customers, geographies, etc. |
| Focus | Focus on historical data | Analyze historical data to offer future directions |
| Format | Follow a fixed format based on accounting principles such as GAAP, IFRS, etc. | Prepared according to the need. |
| Requirement | Required by compliance authorities | Prepared for the management |
| External authentication | Require external audits | No external verification needed |
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.
How Does ERP Streamline Accounting Process?
Enterprise Resource Planning is a versatile solution that provides an agile cloud-based infrastructure to maintain the books of accounts and streamline the recording of business transactions and accounts receivable automation. It comes with a diverse set of modules that benefit different business functions, provide a 360-degree view of business operations, and support rapid business growth.
ERP implementation consolidates information from different areas of the business operations and displays versatile charts & reports that enable decision-makers with access to real-time & authentic information, and data-driven strategies to support rapid growth & expansion. ERP reduces human errors, discrepancies, and compliance risks and ensures your financial accounts are audit-friendly.
Final Words
Financial and management accounting are essential for a business, each serving specific purposes. Understanding the difference between financial accounting and management accounting will empower you to utilize them for your advances. However, preparing these reports can be daunting without the use of specialized tools such as ERP Software.
Sage X3 is an exceptional solution with integrated financial management tools for recording, tracking, and analyzing every transaction for simplified reporting. It streamlines the process, improves accuracy, and helps you meet regulatory requirements. Furthermore, it aids in other business activities from production planning, inventory management, and quality control to customer support.
FAQs
1. What is the Definition of Financial Accounting?
Financial accounting meaning is that it is a process of tracking, recording, summarizing, and reporting financial transactions to gain information on a company’s commercial performance. It is a prerequisite for companies to communicate their financial performance with a dispersed audience.
2. What is the Definition of Management Accounting?
Management accounting meaning is that it is the process of identifying, summarizing, analyzing, and communicating a company’s financial performance to the managers. Management accounting reports may encompass details on product costing, budgeting, forecasting, etc. Management accounting allows them to make future decisions that align with the long-term goals of the organization.
3. What’s the Accrual Method of Financial Accounting?
The accrual method is a process of recording transactions when earned or incurred. Following the double-entry accounting method, accrual accounting records transactions at the time of initiation, independent of cash usage.
For example, a company received a bill of ₹1000 from a vendor to pay in the next month. Under the accrual method, the company must record the transaction this month even though cash transactions will not happen until next month.
4. What’s the Cash Accounting Method of Financial Accounting?
Cash accounting or cash-based accounting records transactions when the actual cash is received or debited. For example, a company receives payment for a service due next month. Under the cash accounting method, the company will record the transaction under revenue since it has received cash.
5. What Are the Financial Accounting Principles?
The most popular accounting principles are — the GAAP and the IFRS methods. GAAP is the accounting principle followed in the USA, whereas the IFRS is practiced in 110 countries. Accounting principles bring standardization to record financial dealings across companies and counties, make them easily comparable, and eliminate chances of fraud.
