The Differences Between Financial Accounting & Management Accounting

by K.A. Francis

Financial and management accounting are both important tools for a business, but serve different
purposes. A business uses accounting to determine operational plans in the future, to review past
performance and to check current business functions. Management and financial accounting have
different audiences, as investors are not usually involved in the day-to-day operations of the
business but are concerned about their investment, whereas managers need information quickly
to make daily business decisions.

Financial Accounting
Financial accounting is used to present the financial health of an organization to its external
stakeholders. Board of directors, stockholders, financial institutions and other investors are the
audience for financial accounting reports. Financial accounting presents a specific period of time
in the past and enables the audience to see how the company has performed. Financial
accounting reports must be filed on an annual basis, and for publically traded companies, the
annual report must be made part of the public record.
Management Accounting
Management or managerial accounting is used by managers to make decisions concerning the
day-to-day operations of a business. It is based not on past performance, but on current and
future trends, which does not allow for exact numbers. Because managers often have to make
operation decisions in a short period of time in a fluctuating environment, management
accounting relies heavily on forecasting of markets and trends.
Differences
Management accounting is presented internally, whereas financial accounting is meant for
external stakeholders. Although financial management is of great importance to current and
potential investors, management accounting is necessary for managers to make current and
future financial decisions. Financial accounting is precise and must adhere to Generally
Accepted Accounting Principles (GAAP), but management accounting is often more of a guess
or estimate, since most managers do not have time for exact numbers when a decision needs to
be made.
Why Management Accounting Is Important in Decision-Making
by John Freedman; Updated June 27, 2018
Small business owners and managers are faced with countless decisions every business day.
Management accounting uses information from your operations to produce reports that provide
ongoing insight into business performance, such as profit margin and labor utilization, so you
and your managers have data-driven input to make everyday decisions. Small businesses can
leverage this powerful trove of calculations to improve decision-making over time for higher
profitability and greater competitive advantage.
Relevant Cost Analysis
Managerial accounting information is used by company management to determine what should
be sold and how to sell it. For example, a small business owner may be unsure where he should
focus his marketing efforts. To evaluate this decision, an accounting manager could examine the
costs that differ between advertising alternatives for each product, ignoring common costs. This
process is known as relevant cost analysis and is a technique that is taught in basic managerial
accounting courses. The same process can be used to determine whether to add product lines or
discontinue operations.
Activity-based Costing Techniques
Once the company has determined what products to sell, the business needs to determine to
whom they should sell the products. By using activity-based costing techniques, small business
management can determine the activities required to produce and service a product line.
Embedded in this information is the cost of customers. Deciding which customers are more or
less profitable allows the business owner to focus advertising toward the consumers who are the
most profitable.
Make or Buy Analysis
A primary use of managerial accounting information is to provide information used in
manufacturing. For example, a small business owner may be considering whether to make or buy
a component needed to manufacture the company's primary product. By completing a make or
buy analysis, she can determine which choice is more profitable. While this technique is
certainly useful, small business owners should only use these analyses as a factor in the decision.
There could be other non-financial metrics that are important to consider that would not be part
of the analysis.
Utilizing the Data
Managerial accounting information provides a data-driven look at how to grow a small business.
Budgeting, financial statement projections and balanced scorecards are just a few examples of
how managerial accounting information is used to provide information to help management
guide the future of a company. By focusing on this data, managers can make decisions that aim
for continuous improvement and are justifiable based on intelligent analysis of the company data,
as opposed to gut feelings.
How Can Managers Use Accounting Information?
by Devra Gartenstein; Updated June 30, 2018
Accounting information provides feedback about operations and profitability. As a manager,
these numbers are indispensable to you in that they tell you which aspects of your business work
well, and which aspects where you have room for improvement. Although accounting
information provides invaluable insight, it's usually not the last word about what's going on in
your company. Rather, it's a good place to start the process of asking questions and for making
direct observations.
The Earnings Statement
The bottom line of your earnings statement provides a snapshot as to whether your company is
functioning as it should. If this number shows a profit, then your operations are fundamentally
successful, because you're earning more than you spend. If your bottom line shows a loss, then
you're spending more than you earn, and something must be corrected. Of course, this analysis is
an oversimplification, and your business may have been profitable or unprofitable because of a
one-time occurrence, such as a windfall or a disaster. Bring this knowledge of extenuating
circumstances to your thought process as well, and brainstorm about how to build on your
successes and overcome your adversities. Your earnings statement will also break down your
income and expenses into categories, showing where you have been most successful and where
there is room for improvement.
Balance Sheet
Your balance sheet tells what your company is worth, and how your profit and loss has translated
over time into assets you own and liabilities you owe. It also tells you where your assets have
accumulated, and whether they are liquid, such as bank account balances, or whether they are
tied up in tangible investments, such as equipment, which you can’t easily sell. As a manager,
this information is useful to you, because it provides you with background for making financing
decisions. For example, if you’re considering an expansion that will require capital, your balance
sheet will tell you whether or not you’re in a position to take on additional debt.
Cash Flow Statement
Your cash flow statement shows how funds flow in and out of your company over time. This
information is vital to managers, who must figure out how to pay for day-to-day expenditures
and also how to plan longer term budget items such as loan repayments. Your cash flow
statement can help you anticipate shortfalls and proactively plan to cover short term shortfalls. It
will also show you when you're likely to have a surplus, so you can plan capital improvements to
coincide with these opportunities.
General Uses of Accounting Information
by Osmond Vitez; Updated August 01, 2018
Accounting provides companies with various pieces of information regarding business
operations. It is often conducted by a company's internal accounting department and reviewed by
a public accounting firm. Small businesses often have significantly less financial information
recorded during the accounting process. However, business owners often review this financial
information to determine how well their business is operating. Accounting information can also
provide insight on growing or expanding current business operations.
Performance Management
A common use of accounting information is measuring the performance of various business
operations. While financial statements are the classic accounting information tool used to assess
business operations, business owners may conduct a more thorough analysis of this information
when reviewing business operations. Financial ratios use the accounting information reported on
financial statements and break it down into leading indicators. These indicators can be compared
to other companies in the business environment or an industry standard. This helps business
owners understand how well their companies operate compared to other established businesses.
Create Budgets
Business owners often use accounting information to create budgets for their companies.
Historical financial accounting information provides business owners with a detailed analysis of
how their companies have spent money on certain business functions. Business owners often
take this accounting information and develop future budgets to ensure they have a financial road
map for their businesses. These budgets can also be adjusted based on current accounting
information to ensure a business owner does not restrict spending on critical economic resources.
Business Decisions
Accounting information is commonly used to make business decisions. For financial
management, an income statement and accounting of expenses provides an important overview
of the business. Decisions may include expanding current operations, using different economic
resources, purchasing new equipment or facilities, estimating future sales or reviewing new
business opportunities. Accounting information usually provides business owners information
about the cost of various resources or business operations. These costs can be compared to the
potential income of new opportunities during the financial analysis process. This process helps
business owners understand how current business operations will be affected when expanding or
growing their businesses. Opportunities with low income potential and high costs are often
rejected by business owners.
Investment Decisions
External business stakeholders often use accounting information to make investment decisions.
Banks, lenders, venture capitalists or private investors often review a company’s
accounting information to review its financial health and operational profitability. This provides
information about whether or not a small business is a wise investment decision. Many small
businesses need external financing to start up or grow. The inability to provide outside lenders or
investors with accounting information can severely limit financing opportunities for a small
business.

accounting

Practice and body of knowledge concerned primarily with

methods for recording transactions,
keeping financial records,
performing internal audits,
reporting and analyzing financial information to the management, and
advising on taxation matters.
It is a systematic process of identifying, recording, measuring, classifying, verifying,
summarizing, interpreting and communicating financial information. It reveals profit or loss for a
given period, and the value and nature of a firm's assets, liabilities and owners' equity.

Accounting provides information on the

resources available to a firm,

the means employed to finance those resources, and
the results achieved through their use.

What is accounting?

Accounting is the recording of financial transactions plus storing, sorting, retrieving,

summarizing, and presenting the information in various reports and analyses. Accounting is also
a profession consisting of individuals having the formal education to carry out these tasks.

One part of accounting focuses on presenting the information in the form of general-
purpose financial statements (balance sheet, income statement, etc.) to people outside of the
company. These external reports must be prepared in accordance with generally
accepted accounting principles often referred to as GAAP or US GAAP. This part of accounting
is referred to as financial accounting.
Accounting also entails providing a company's management with the information it needs to
keep the business financially healthy. These analyses and reports are not distributed outside of
the company. Some of the information will originate from the recorded transactions but some of
the information will be estimates and projections based on various assumptions. Three examples
of internal analyses and reports are budgets, standards for controlling operations, and estimating
selling prices for quoting new jobs. This area of accounting is known as management accounting.

Another part of accounting involves compliance with government regulations pertaining to

income tax reporting.

Today much of the recording, storing, and sorting aspects of accounting have been automated as
a result of the advances in computer technology.

Bookkeeping - What is bookkeeping?

Bookkeeping is the systematic recording and organising of financial transactions in a

company

Bookkeeping is the recording, on a day-to-day basis, of the financial transactions and

information pertaining to a business. It ensures that records of the individual financial
transactions are correct, up-to-date and comprehensive. Accuracy is therefore vital to
the process.START MANAGING YOUR ACCOUNTS

Bookkeeping provides the information from which accounts are prepared. It is a distinct
process, that occurs within the broader scope of accounting.

Each transaction, whether it is a question of purchase or sale, must be recorded. There

are usually set structures in place for bookkeeping that are called ‘quality controls’,
which help ensure timely and accurate records.
Bookkeeping tasks

Essentially, bookkeeping means recording and tracking the numbers involved in the
financial side of the business in an organised way. It is essential for businesses, but is
also useful for individuals and non-profit organisations.

The person(s) responsible for bookkeeping for a business would record all transactions
that are related, including but not limited to:

 Expense payments to suppliers

 Loan payments
 Customer payments for invoices
 Monitoring asset depreciation
 Generating financial reports

Bookkeeping and accounting are often heard being used interchangeably, however,
accounting is the overall practice of managing finances of a business or individual, while
bookkeeping refers more specifically to the tasks and practices involved in recording the
financial activities.

Why bookkeeping matters

While it may seem obvious, detailed, thorough bookkeeping is crucial for businesses of
all sizes. Seemingly straightforward, bookkeeping quickly becomes more complex with
the introduction of tax, assets, loans, and investments.

Tracking the financial activities of a business is the truest purpose of bookkeeping,

meaning it allows you to keep an up-to-date record of the current incoming and outgoing
amounts, amounts owed by customers and by the business, and more.

Traditional bookkeeping

Bookkeeping has a long history as an integral part of accounting. Traditionally, it

involves ledgers, charts of accounts, and a tedious double-entry system. You can read
more about the history of invoicing & accounting in our blog post: 'Invoicing & accounting:
a journey through history.

Here we'll cover how the main activities are recorded in traditional bookkeeping
practices, which are still used to this day.

Recording transactions

In principle, transactions must be recorded daily into the books or the accounting
system.

For each transaction, there must be a document that describes the business
transaction. This could include a sales invoice, sales receipt, a supplier invoice, a
supplier payment, bank payments and journals.

These accompanying documents provide the audit trail for each transaction and are an
important part of maintaining accurate records in the event of an audit.

Double-entry bookkeeping

The double entry system of bookkeeping is based on the fact that every transaction has
two parts, which therefore affects two ledger accounts.

Every transaction involves a debit entry in one account and a credit entry in another
account. This serves as a kind of error-detection system: if, at any point, the sum of
debits does not equal the corresponding sum of credits, then an error has occurred.

Bookkeeping options today

It seems there is no industry that advances in technology (read: the internet) has not
affected. Bookkeeping is no exception. Bookkeeping used to involve multiple ledgers,
then multiple Exel files...essentially an inordinate amount of paper or computer files.
Storage quickly becomes an issue and organisation can be a challenge.

Technological advances facilitated a move to a computer-based system, with software

available to purchase and download to a desktop. Even then, these programs could be
costly and slow.
Continued development have led to what is available today: 100% online applications,
backed up in the cloud, with unlimited storage. This means no downloads and buggy
updates, no concern over losing documents due to computer crashes or viruses, and no
problems with storage space online or off.

New options have also been opened by the boom of Android and iPhone mobile apps,
allowing you to manage your accounting even on the go.

Bookkeeping and Debitoor

Say goodbye to tedious books and ledgers. With a cloud-based accounting system like
Debitoor, it’s easy to record income, expenses, and use automatic bank reconciliation to
make sure your credits equal your debits.

Introduction to Debits and Credits

If the words "debits" and "credits" sound like a foreign language to you, you are more perceptive
than you realize—"debits" and "credits" are words that have been traced back five hundred years to
a document describing today's double-entry accounting system.

Under the double-entry system every business transaction is recorded in at least two accounts. One
account will receive a "debit" entry, meaning the amount will be entered on the left side of that
account. Another account will receive a "credit" entry, meaning the amount will be entered on
the right side of that account. The initial challenge with double-entry is to know which account should
be debited and which account should be credited.
Before we explain and illustrate the debits and credits in accounting and bookkeeping, we will
discuss the accounts in which the debits and credits will be entered or posted.

What Is An Account?
To keep a company's financial data organized, accountants developed a system that sorts
transactions into records called accounts. When a company's accounting system is set up, the
accounts most likely to be affected by the company's transactions are identified and listed out. This
list is referred to as the company's chart of accounts. Depending on the size of a company and the
complexity of its business operations, the chart of accounts may list as few as thirty accounts or as
many as thousands. A company has the flexibility of tailoring its chart of accounts to best meet its
needs.
Within the chart of accounts the balance sheet accounts are listed first, followed by the income
statement accounts. In other words, the accounts are organized in the chart of accounts as follows:
  Assets
 Liabilities
 Owner's (Stockholders') Equity
 Revenues or Income
 Expenses
 Gains
 Losses

Double-Entry Accounting
Because every business transaction affects at least two accounts, our accounting system is known as
a double-entrysystem. (You can refer to the company's chart of accounts to select the proper
accounts. Accounts may be added to the chart of accounts when an appropriate account cannot be
found.)
For example, when a company borrows $1,000 from a bank, the transaction will affect the
company's Cash account and the company's Notes Payable account. When the company repays the
bank loan, the Cash account and the Notes Payable account are also involved.
If a company buys supplies for cash, its Supplies account and its Cash account will be affected. If the
company buys supplies on credit, the accounts involved are Supplies and Accounts Payable.
If a company pays the rent for the current month, Rent Expense and Cash are the two accounts
involved. If a company provides a service and gives the client 30 days in which to pay, the
company's Service Revenues account and Accounts Receivable are affected.
Although the system is referred to as double-entry, a transaction may involve more than two
accounts. An example of a transaction that involves three accounts is a company's loan payment to
its bank of $300. This transaction will involve the following accounts: Cash, Notes Payable, and
Interest Expense.

(If you use accounting software you may not actually see that two or more accounts are being
affected due to the user-friendly nature of the software. For example, let's say that you write a
company check by means of your accounting software. Your software automatically reduces your
Cash account and prompts you only for the otheraccounts affected.)

Debits and Credits

After you have identified the two or more accounts involved in a business transaction, you must debit
at least one account and credit at least one account.

To debit an account means to enter an amount on the left side of the account. To credit an account
means to enter an amount on the right side of an account.

Here's a Tip
Debit means left
Credit means right

Generally these types of accounts are increased with a debit:

Dividends (Draws)
Expenses
Assets
Losses
You might think of D - E - A - L when recalling the accounts that are increased with a debit.

Generally the following types of accounts are increased with a credit:

Gains
Income
Revenues
Liabilities
Stockholders' (Owner's) Equity
You might think of G - I - R - L - S when recalling the accounts that are increased with a credit.
To decrease an account you do the opposite of what was done to increase the account. For example,
an asset account is increased with a debit. Therefore it is decreased with a credit.
The abbreviation for debit is dr. and the abbreviation for credit is cr.

Journal Entries

T-accounts
Accountants and bookkeepers often use T-accounts as a visual aid for seeing the effect of the debit
and credit on the two (or more) accounts. (Learn more about accountants and bookkeepers in
our Accounting Career Center.)
We will begin with two T-accounts: Cash and Notes Payable.
Let's demonstrate the use of these T-accounts with two transactions:

1. On June 1, 2017 a company borrows $5,000 from its bank. This causes the company's asset
Cash to increase by $5,000 and its liability Notes Payable to also increase by $5,000. To
increase the asset Cash the account needs to be debited. To increase the company's liability
Notes Payable this account needs to be credited. After entering the debits and credits the T-
accounts look like this:

2. On June 2, 2017 the company repaid $2,000 of the bank loan. This causes the company's
asset Cash to decrease by $2,000 and its liability Notes Payable to also decrease by $2,000.
To reduce the asset Cash the account will need to be credited for $2,000. To decrease the
liability Notes Payable that account will need to be debited. The T-accounts now look like
this:
Journal Entries
Another way to visualize business transactions is to write a general journal entry. Each general journal
entry lists the date, the account title(s) to be debited and the corresponding amount(s) followed by
the account title(s) to be credited and the corresponding amount(s). The accounts to be credited are
indented. Let's illustrate the general journal entries for the two transactions that were shown in the T-
accounts above.

When Cash Is Debited and Credited

Because cash is involved in many transactions, it is helpful to memorize the following:

 Whenever cash is received, debit Cash.

 Whenever cash is paid out, credit Cash.
With the knowledge of what happens to the Cash account, the journal entry to record the debits and
credits is easier. Let's assume that a company receives $500 on June 3, 2017 from a customer who
was given 30 days in which to pay. (In May the company recorded the sale and an accounts
receivable.) On June 3 the company will debit Cash, because cash was received. The amount of the
debit and the credit is $500. Entering this information in the general journal format, we have:

All that remains to be entered is the name of the account to be credited. Since this was the collection
of an account receivable, the credit should be Accounts Receivable. (Because the sale was already
recorded in May, you cannot enter Sales again on June 3.)
On June 4 the company paid $300 to a supplier for merchandise the company received in May. (In
May the company recorded the purchase and the accounts payable.) On June 4 the company will
credit Cash, because cash was paid. The amount of the debit and credit is $300. Entering them in
the general journal format, we have:
All that remains to be entered is the name of the account to be debited. Since this was the payment
on an account payable, the debit should be Accounts Payable. (Because the purchase was already
recorded in May, you cannot enter Purchases or Inventory again on June 4.)
To help you become comfortable with the debits and credits in accounting, memorize the following
tip:

Here's a Tip
Whenever cash is received, the Cash account is debited (and another account is credited).

Whenever cash is paid out, the Cash account is credited (and another account is debited).

Sample Chart of Accounts for a Small

Company
This is a partial listing of another sample chart of accounts. Note that each account is assigned a
three-digit number followed by the account name. The first digit of the number signifies if it is an
asset, liability, etc. For example, if the first digit is a "1" it is an asset, if the first digit is a "3" it is a
revenue account, etc. The company decided to include a column to indicate whether a debit or credit
will increase the amount in the account. This sample chart of accounts also includes a column
containing a description of each account in order to assist in the selection of the most appropriate
account.
Asset Accounts
Liability Accounts

Owner's Equity Accounts

Operating Revenue Accounts

Operating Expense Accounts

Non-Operating Revenues and Expenses, Gains, and Losses

Accounting software frequently includes sample charts of accounts for various types of businesses.
It is expected that a company will expand and/or modify these sample charts of accounts so that the
specific needs of the company are met. Once a business is up and running and transactions are
routinely being recorded, the company may add more accounts or delete accounts that are never
used.

At Least Two Accounts for Every

Transaction
The chart of accounts lists the accounts that are available for recording transactions. In keeping with
the double-entry system of accounting, a minimum of two accounts is needed for every transaction—at
least one account is debited and at least one account is credited.
When a transaction is entered into a company's accounting software, it is common for the software
to prompt for only one account name—this is because the software is programmed to automatically
assign one of the accounts. For example, when using accounting software to write a check, the
software automatically reduces the asset account Cash and prompts you to designate
the other account(s) such as Rent Expense, Advertising Expense, etc.
Some general rules about debiting and crediting the accounts are:

 Expense accounts are debited and have debit balances

 Revenue accounts are credited and have credit balances

 Asset accounts normally have debit balances

 To increase an asset account, debit the account
 To decrease an asset account, credit the account

 Liability accounts normally have credit balances

 To increase a liability account, credit the account
 To decrease a liability account, debit the account