Management accounting is a format of a company’s financial reporting primarily used for making managerial decisions. Unlike financial and tax accounting, the purpose of management accounting is to enable the company’s management and investors to understand the real financial picture, conduct structured financial analysis, and make well-founded qualitative management decisions regarding the future development of the business.
In what format should management accounting be conducted?
It is most convenient to conduct management accounting in three main reports that are used by all systemic companies worldwide: the Balance Sheet, the Profit and Loss Statement (P&L or Income statement), and the Cashflow Statement.
The high-level structure of these reports should adhere to accepted international standards, but the content of individual items may be developed based on the specifics of the particular business.
If you are unfamiliar with the data formats of these reports, you can download them and review the instructions on how to work with them at the following link:.
main management reports
+ a video tutorial on how to use them
Types of management reports
Management reports are divided into two types:
1. Momentary. They show the situation at a specific point in time, such as the indicator of cash or inventory balances on a certain date. The Balance Sheet is a momentary report.
2. Interval. They display the dynamics and changes over a specific period. For example, a metric like the sum of cash inflows and outflows for a particular month. The Profit and Loss Statement (P&L) and Cashflow Statement are interval reports.
What is the Purpose of the Balance Sheet?
In the balance sheet, we see all momentary indicators of the company, including:
- Company assets (cash, inventory, equipment, accounts receivable, real estate, transportation, etc.).
- Company liabilities (debts for salaries, taxes, payables to suppliers, creditors, etc.).
Therefore, the balance sheet reflects the totality of all assets and liabilities of the company.
Additionally, in the balance sheet, the owner sees one of the most important indicators of the company’s financial status called equity. This is the difference between the balance value of all assets and liabilities of the company, reflecting the size of the capital frozen in the business. In other words, equity is the amount of money that hypothetically would remain with the shareholders of the company in case of its cessation, selling all assets of the enterprise at their balance value, and repaying all debts. Such a situation is unlikely for a business but explains the essence of equity.
It is important to understand that the net profit or loss of the company relates specifically to changes in the size of equity. In other words, a net profit of $10,000 per month does not mean that the company has that amount of additional money in its account, but rather that its equity has increased by that amount.
Why is the Profit and Loss Statement (P&L) needed?
The Profit and Loss Statement (P&L) is used for accounting and analyzing the net profit/loss and its formation structure. It shows not how money is moving (which is evident in the Cash Flow Statement) but the net profit or loss calculated based on the company’s revenues and expenses accrued for a specific period.
By accrued revenues and expenses, we mean not the actual receipt or payment of money but the recognition of such revenues and expenses.
For instance, a company may receive an advance payment for a service in January but perform the service in February. In this case, the month of revenue recognition will be February, and this amount will be reflected in the February income in the P&L. The advance payment received in January will be reflected in the Cash Flow. Or, for example, employees may be credited with their salaries for April, and this accrual amount will be reflected in the Profit and Loss Statement for April, regardless of the date of actual salary payment. However, the actual movement of cash for this expense category may occur at the beginning of May, and then, it will be reflected in the Cashflow in May.
Why is the Cashflow Statement needed?
A typical mistake made by young entrepreneurs is calculating net profit using the cash method, considering it as the difference between all cash inflows and outflows. In international financial management standards, this difference is called Net Cash Flow and is used to manage the liquidity of the company (ensuring an adequate amount of money to sustain continuous operations and fulfill all obligations). The Cashflow Statement is specifically used for accounting and analyzing the net cash flow and its formation structure. There the entrepreneur can see all cash inflows and outflows, the net cash flow, as well as cash balances at the beginning and end of each period.
How to implement management accounting?
The algorithm for implementing management accounting is as follows:
- Identify an employee responsible for management accounting.
- Develop formats for management reports (Balance Sheet, P&L, Cashflow).
- Choose and implement an accounting automation system (initially, this could be Excel or Google Spreadsheet, but it is essential to transition to a more automated system as quickly as possible, such as Finmap).
- Compile a list of primary operations based on which management reporting will be formed (payments, expense accruals, signing acts of completed work, revenue and expenditure invoices, etc.).
- Determine how each primary operation will be entered into the management accounting system and who is responsible for it.
- Embed the conduct of all primary operations in the management accounting system in the business processes of the company (for example, in BPMN format).
- Train employees involved in management accounting operations.
- Determine mechanisms for verifying the correctness of management reporting and implement regular audits.
Who should handle management accounting?
Ideally, management accounting should be built and managed by the Chief Financial Officer (CFO). In small companies, this function may be performed by a financial manager. It is not recommended to assign management accounting to the Chief Accountant, as their main tasks are in the areas of accounting and tax accounting, ensuring high-quality reporting to state regulatory authorities.
