We are going to look at financial accounting and managerial accounting in this and future blogs. They are very similar, but the goals are very different.
Both utilize accrual accounting to align revenues and costs to report an accurate profit margin. However, financial accounting focuses on accuracy from an investor’s prospective while managerial accounting focuses on accuracy from a manager’s prospective. In this case, think of investor’s prospective like putting money in the stock market or a passive activity (for you tax guys). The main goal is to get a return on your investment with little to no involvement on your part.
These are important differences because the goals of investors and managers do not always align.
As an investor, your main goal is return on your investment. When looking at two different investments, they need to have similar accounting principles so that the companies can be seen as comparable investments.
Two companies can be in the same industry, but if they do not use the same accounting standards – you are not comparing apples-to-apples. This is what lead to the development of Generally Accepted Accounting Principles (GAAP) that public companies are required to use in financial statements. Any departures from GAAP need to be stated within the report so the investor can know.
The goal of a manager is to be efficient and effectively use available resources (labor, capital, and markets) to maximize profit. No business, country, or person has unlimited resources at their disposal, so it is important to know what allocations are of best use.
This is one of the reasons the use of metrics became so prevalent in the business world; managers started to recognize that you can spot good financial managers through the profitability in their area of responsibility.
While the idea of revenue – expenses = profit is pretty straight-forward, what is considered a “revenue” and an “expense” can be argued depending upon perspective. A deferred grain contract is a good example. From a cash basis, you moving income into the next year in order to control taxable income. From an accrual basis, that grain is income the day your sign the contract regardless of when you actually receive the check. If you are a farm manager and your annual bonus depended upon annual net income, which accounting basis would you rather use? Probably the one that includes that deferred grain contract when you actually sold it, increasing the net income in the current year and giving you a bigger bonus.
In future posts we will get more in depth between some of the specific differences that come into play at an accounting and transactional level between financial and managerial accounting. The important thing right now is to understand that there is a difference – so be ready to ask questions if someone starts using them interchangeably.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.