Entrepreneurship is a long and exciting journey. But making the right decisions for your company over and over again can be a daunting challenge.
Your business’s long-term success relies on you making informed decisions. That means not just relying on your gut but understanding all the levers that affect your results. One of the best ways to do that is through the practice of managerial accounting.
What is managerial accounting?
Managerial accounting is the process of measuring and analyzing your company’s financial data for the purpose of informing the decision-making process for managers. You can also use it to support a wide range of business decisions, including budget creation, vendor selection, product selection, and defining sales and marketing strategies.
You may also hear managerial accounting referred to as management accounting.
Cost accounting vs. managerial accounting
Cost accounting is another related term. It refers to a specific type of managerial accounting that helps you calculate your business’s total cost of production and the per-unit production cost of all the products you sell.
As a result, cost accounting can help you do a profit analysis of your product line to see which items make the most money.
Types of cost accounting methods include:
- Standard costing: Using estimated costs (known as standard costs) for different products and business activities. Standard costing is often used to create budgets or determine product prices.
- Variable costing: Using real expenses to determine per-unit costs. In variable costing, fixed overhead expenses aren’t used to calculate product costs.
- Absorption costing: An alternative to variable costing, where both fixed and variable overhead costs are included in product costs.
- Activity-based costing: This method calculates the cost of each product or service by adding up the costs of all the associated business activities, such as manufacturing, order processing, and customer service. It’s often the most accurate method, but also more complex and time-consuming.
Financial accounting vs. managerial accounting
Financial accounting summarizes and reports your company’s financial performance for external stakeholders, such as investors. In contrast, you only use managerial accounting for internal decision-making.
Since financial accounting information gets reported outside of the business, those reports have to follow standard accounting practices, like the Generally Accepted Accounting Principles (GAAP). Common financial statements include balance sheet, income statement, and cash flow statement.
Managerial accounting doesn’t need to follow predefined reporting standards and can vary from company to company.
In addition, financial accounting is usually concerned with the performance of the entire company, while managerial accounting reports may only deal with a single department or issue. You can tailor the reports you generate for internal use based on the business problem you’re trying to solve.
Types of managerial accounting
Here are a few types of managerial accounting techniques businesses use to help solve problems and make more informed decisions.
- Marginal analysis: Comparing the additional benefits of an activity to its cost. This type of analysis is often used to optimize production and to calculate the breakeven point at which you start earning a profit.
- Variance analysis: Comparing your actual performance with projections to analyze the accuracy of your budget.
- Capital budgeting and forecasting: Planning and predicting costs and income to ensure that your financial performance aligns with overall business goals.
- Cash flow analysis: Measuring and analyzing how cash flows in and out of the business. It’s often used to improve your company’s financial stability.
- Constraint analysis: Reporting used to identify and remove bottlenecks in the business to increase profitability.
- Financial leverage ratios: Calculation of metrics such as your debt ratio or debt-to-equity ratio to understand your company’s finances relative to your current debt. You can use them to assess your financial stability and level of financial risk.
- Inventory turnover analysis: Measuring and analyzing how long it takes for you to sell items in your inventory so you can optimize inventory orders and reduce problems such as overstocking.
- Accounts receivable (AR) management: Monitoring, analyzing, and optimizing how long it takes for customers to pay their invoices so you can improve how efficiently cash flows into your business.
- Inventory valuation and product costing: The process of measuring and calculating the costs associated with manufacturing or selling individual items in order to better understand the cost of goods sold (COGS) and profitability of your products.
Ways to apply managerial accounting information
Insights you gain from managerial accounting have a wide range of applications in business. Some examples of practical ways to apply your managerial accounting information are to:
- Find areas to cut costs
- Identify ways to increase revenue
- Monitor and reduce overspending
- Allocate your resources more effectively
- Adjust your budget based on real-time data
- Adjust revenue streams based on profitability
How to get started with managerial accounting
As mentioned earlier, management accounting isn’t as standardized as financial accounting. Your process and reports may look different when compared to another company, and that’s because they’re tailored to your goals and needs.
That being said, there are some general steps you can follow to get started.
1. Define your goals
Clarify what you want to accomplish with your managerial accounting. Most businesses use it to help with ongoing objectives, such as increasing profitability and controlling spending. For these types of goals, you can continuously use managerial accounting to learn and improve.
You may also decide to create reports that help you dig into a specific problem, such as an increase in late invoice payments or stale inventory.
2. Identify key performance indicators (KPIs)
Choose the managerial accounting techniques and key performance indicators (KPIs) that are most relevant to your goals.
Thomas Villalpando, co-founder of dog training and product review company IPet Guides, lists “gross margin, customer acquisition cost (CAC), and return on investment (ROI)” as good starting points for management accounting.
You may also want to track industry-specific KPIs that help you benchmark performance against competitors.
For instance, ecommerce businesses may track average order size and revenue per visitor, while a manufacturing company would focus more on return on assets (ROA) and overall equipment effectiveness.
3. Collect the data
Once you know which KPIs you want to track, begin collecting the data. You can do this manually through Excel or Google Sheets, but automating data collection can help speed up the process. Automating this step also reduces manual data entry errors and ensures more accurate information.
At the very least, you want to invest in a robust accounting software that includes reporting, automation, and integration features. Examples of reliable accounting software providers with automation features include QuickBooks, FreshBooks, and Oracle NetSuite.
Access to real-time income and spending data can help you proactively control costs and take advantage of income opportunities faster.
4. Analyze and apply your findings
The final step involves analyzing the data to find actionable insights for your business. During this step, it’s helpful to look for trends, outliers, and variance.
Here are examples of how those three could appear if you were monitoring customer acquisition cost (CAC) as a KPI.
- Trend: CAC increased X% month to month.
- Outlier: CAC costs in June were Y% lower than your typical monthly average.
- Variance: Your average CAC is Z% higher than you predicted.
Once again, investing in the right technology can help streamline your process. Platforms with built-in reporting features make it easier to do trend analysis and quickly generate financial reports for you to review.
Look at your detailed data to figure out the cause of the trend, outlier, or variance. For instance, CAC variance could be a result of higher-than-expected advertising costs.
From there, take action to help move your business toward your goals. If you want to lower your CAC cost, you may choose to look for different advertising channels or invest more in organic growth strategies, like search engine optimization (SEO).
Managerial accounting may not be required, but it’s an excellent way to really learn the ins and outs of your business and give yourself a competitive edge when it comes to financial management.
At the end of the day, the success of your business will be the result of the choices you made along the way. With managerial accounting, you use your company’s actual financial information to make smarter, more informed choices that can lead to more growth over time.
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