Management accounting focuses on internal measures rather than external reporting. It forms the basis of decision-making in companies, both because it is ongoing and timely and because it focuses on measures that help the company be more efficient and effective, rather than focusing on reporting based on external reporting standards.
Management Versus Financial Accounting
Every company prepares external financial statements for income tax purposes. Companies may also have to show their external statements to creditors, investors and other interested parties. External statements are based on generally accepted accounting principles, which represent valuation and measurement rules that are standardized in order to make financial statements comparative across companies. Management accounting is a process of measuring internal performance in order to make companies more effective, efficient and profitable. The benchmarks, ratios and other indicators are developed in-house to track profit drivers critical to the company's success.
One of the main benefits of management accounting is timeliness. The more current measurements are, the more relevant they are in management decision-making. The focus is on what is happening in the business right now rather than a historical accounting of what happened months or even a year ago. When timely performance benchmarks indicate that the company is moving toward problems, a course correction can be made in real time to get it back on track. For example, if the inventory turnover ratio begins to drop rapidly, it indicates a reduction in sales or a build up of inventory, both of which can have a serious impact on the bottom line. Early detection can help alert management that it needs to find the root cause of the problem before the company loses money.
Focus on Efficiency and Effectiveness
Management accounting indicators are geared toward measuring how efficient and effective a company is. Efficiency means that the company is generating the highest return from the lowest amount of capital. Effectiveness means that the company is generating those returns quickly and with no negative impacts. These measures are important to both internal managers to steer the direction of the company and to investors, who want to ensure that their investments are generating returns.
Another benefit of management accounting is that it allows managers to make incremental changes in the business operations and to track the results in real time. For example, the marketing department may implement a new ad campaign that costs $10,000 over the next year. Benchmarks can be designed that track all new customers' activity and what brought them to the company. In this manner, managers can determine if the $10,000 was a good investment or not.
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