Financial Accounting provides financial reports for external stakeholders, in mandated formats, based on historic actual performance at the macro level. Management Accounting, in the first instance, provides predictive information, extending down into the micro level, for the CEO and operating management. As the reporting year rolls on, management accounts use flexible budgeting to link actual performance with predictions to provide genuine, “this is how we are doing compared with plan” information and in so doing, directs management’s attention to any factors inhibiting planned performance.
The Management Accounting process can be broken down into these building blocks:
Costing and Pricing
The overall financial performance of an organisation is the sum of the performances of all products or services sold, the performance measure being revenue minus cost. This calls for an identification of revenues and accurate knowledge of costs by individual product.
A tabulation of these revenues and costs enables management to sort the wheat from the chaff, and given that the tabulation may comprise a substantial number of line items, the use of Pareto (80/20) analyses is usually imperative, as is the ability to query the cost composition of ostensibly, problematic line items by way of drill down into the costs.
Budgets Based on Volume and Price
Budgets should be developed from the product/service level taking into account individual product volume, pricing and costing. Likewise, when conducting variance analysis, actual volumes invoiced should form the basis of a predictive “flexed budget” so that volume, pricing and costing variances can be identified rather than a bland dollar value analysis which does not recognise changes in product mix, price and costs.
Cash Flow forecasts and Funds Flow reports should also be prepared and any variance analysis should include these funding aspects.
Return on Investment & Sensitivity Analysis
Ultimately, all businesses have the goal of generating a “reasonable return” which raises the questions of what is a reasonable return for the individual business, what is the actual return and what are the anticipated future returns?
By using sensitivity analysis, the management accountant can assist management to focus on those areas of the business that will generate the best reward for the least effort, the Pareto Principle at work again!
Whilst a specialty in its own right, Financial Management forms an integral part of Management Accounting and includes funding issues, dividend policy and cost of capital.
In conclusion, practitioners can use Management Accounting to assist clients to focus on Value Creation and at the same time, reduce and eliminate Value Destruction.
Author: Geoff Storey CPA CA, Alliance Advisor with ATL Network