Financial and managerial accounting are two branches of accounting that serve as essential tools for every company. Financial accounting provides a clear picture of the financial health of a company, while managerial accounting helps managers predict the future and make strategic business decisions for growth.
In this blog, we will help you understand the concepts of financial and managerial accounting in simple terms. We will also talk about the difference between financial and managerial accounting, their examples, how they work together, and who cares about these two branches of accounting.
Table of Contents:
What is Financial Accounting?
Financial accounting is a process of recording, summarizing, and reporting a company’s business transactions through financial statements.
Income statement, balance sheet, cash flow statement, and statement of retained earnings are the financial statements involved in financial accounting. Financial accounting exists primarily to present an accurate and clear view of a company’s financial position to external investors and creditors, helping them to make informed decisions.
Further, financial accounting follows the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). It adheres to these principles and standards for reliability and consistency.
What is Managerial Accounting?
Managerial accounting is a process of analyzing and sharing financial and operational data with managers to support better decision-making for business growth.
Also called management accounting, it focuses on internal reporting such as sales, costs, production, and other factors that impact the performance of a company. The main purpose of managerial accounting is to boost efficiency, assist in planning, and track the overall progress of the company.
Difference Between Financial and Managerial Accounting
The main difference between financial accounting and managerial accounting is that financial accounting is the collection of accounting data to generate financial statements, whereas managerial accounting uses internal procedures to analyze and interpret company data for decision-making.
| Basis of Distinction |
Financial Accounting |
Managerial Accounting |
| Purpose |
Records, summarizes, and reports financial transactions to provide a clear picture of a company’s financial position. |
Provides internal information to help management make decisions, plan, and improve performance. |
| Reports |
Income statement, balance sheet, cash flow statement, and statement of retained earnings. Prepared in standardized formats. |
Flexible reports tailored to management’s needs, covering financial, operational, and predictive data. |
| Audience |
Internal users (management, employees) and external users (investors, creditors, regulators). |
Internal users only (management and executives). |
| Rules & Standards |
Must follow GAAP or other accounting standards; legally required. |
No fixed rules or legal requirements; reports are designed as needed. |
| Time Focus |
Primarily historical, covering a fixed period. |
Includes past, present, and future/predictive information; prepared as needed. |
| Use of Information |
Helps stakeholders understand profitability, financial health, and compliance. |
Helps management plan, monitor efficiency, identify problems, and make decisions. |
| Nature |
Objective, verifiable, and general-purpose. |
Flexible, specific-purpose, and may include estimates or projections. |
Key Characteristics of Financial Accounting
Financial accounting is about more than just bookkeeping. It is a well-organized and standardized system with unique features, making the reports trustworthy and useful to investors and creditors.
Here are some of the characteristics of financial accounting:
1. Focus on Monetary Transactions
Financial accounting only records events that can be measured in monetary terms. Factors such as brand reputation, goodwill, and employee morale are important to a company, but not shown in the financial records.
2. Emphasis on Historical Data
Financial reports focus on recording past transactions rather than predicting future ones. This is to provide a clear picture of past performance. However, some accounting standards, like fair value accounting, present a more forward-looking approach by adjusting the asset valuations to their current market price. This offers more up-to-date information on a company’s assets.
3. Compliance with Standards
Financial accounting must follow strict regulatory standards, such as GAAP and IFRS. This is to maintain comparability and consistency, and to ensure all companies follow the same standards when preparing financial statements.
4. Designed for External Stakeholders
The financial reports generated by a company are made available to the public, promoting transparency and trust in financial markets. Simply put, financial accounting is designed for external stakeholders, such as creditors, investors, and government regulators.
5. Business Overview
The financial statements (balance sheet, income statement, and cash flow statement) give a comprehensive picture of the performance and financial position of a company instead of focusing on a particular division or department.
6. Regular and Formal Reporting
All the financial statements are prepared regularly, usually quarterly and annually. Further, the reports are formal and well-structured and often require an external audit for assurance and credibility.
7. Impact of Policy Decisions
A company’s financial statements may differ depending on its accounting policy choices. This can happen even within the traditional framework. A few examples include inventory valuation methods such as FIFO or LIFO, as well as asset depreciation methods. The idea of consistency demands that a company use the same practices over time to remain comparable.
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Example of Financial Accounting
Let’s look at some financial accounting examples to understand the concept better.
XYZ Traders in Bangalore sold ₹10,00,000 worth of furniture for offices to a client. Using financial accounting terms:
- Income Statement (Profit and Loss Account): The ₹10,00,000 sale was recorded as revenue. After deducting expenses such as payroll, rent, and power, it gives the month’s net profit.
- Balance Sheet: The balance sheet shows a rise of ₹10,00,000 in cash or accounts receivable, which updates the company’s total assets and shareholder equity.
- Cash Flow Statement: If the customer is paid right away, the cash inflow of ₹10,00,000 is recorded under operating activities.
These statements follow the Indian Accounting Standards (Ind AS) or Companies (Accounting Standards) Rules, ensuring their reliability and comparability for investors, creditors, banks, and regulators such as the SEBI or Income Tax Department.
Overall, it shows how financial accounting tracks financial activity, summarizes it, and creates standardized reports for outside stakeholders.
Key Characteristics of Managerial Accounting
The primary characteristics of managerial accounting are:
1. Internal Focus
Managerial accounting is tailored for executives, managers, and heads of departments instead of external stakeholders.
2. Future Focused
It focuses on planning, forecasting, and budgeting instead of just documenting historical data.
3. Decision Support
It gives managers important information, helping them to make better decisions, such as allocation of resources, determining prices, and product mix.
4. Flexibility
It doesn’t follow strict guidelines or get limited by standards such as GAAP or IFRS.
5. Use of Specialized Techniques
It uses various tools like budget, standard cost, ratio analysis, cash flow analysis, and fund flow analysis.
6. Internal and Optional
Managerial accounting is neither legally required nor subject to external auditing. It is carried out by a company to serve management’s purposes.
7. Efficiency and Forecasting
It helps in boosting efficiency, monitoring performance, and making predictions about future trends. This helps a company in planning and making strategic choices to achieve the company’s goals.
Example of Managerial Accounting
Let’s take an example of a software company. The company observes that one of its major projects is costing more than planned. In this scenario, managerial accounting checks the software licensing, labour hours, and infrastructure expenses. Finally, the research highlights ineffective resource utilization, allowing managers to transfer people or shift deadlines to save costs.
How Financial and Managerial Accounting Work Together
Financial and managerial accounting are correlated fields that consider similar fundamental information to provide a comprehensive view of a company’s financial position. The following pictures show how data moves between both platforms:
The Financial Foundation
All accounting originates from a single foundation, which is a company’s raw financial transactions. Financial accounting applies a strict, standardized framework for data processing and verification of financial statements for external reporting purposes. This reliable and fact-based information serves as the foundation for all future evaluations.
Managerial Insights from Financial Reports
The collected data from financial reports is the shared foundation for managerial accounting. In case the quarterly income statement reveals an overall profitability drop, management can’t provide an answer without enough data. In such a scenario, a managerial accountant examines the main issue, using financial data to perform a thorough internal investigation.
The Strategic Feedback Loop
Further, Decisions informed by management accounting influence the performance of a company, which is then taken into account in future financial reports. This creates a strong feedback loop in which managerial analysis backs up strategic decisions, which are validated by financial metrics.
The Unified Accounting System
In a well-organized company, financial accounting and management accounting work together and often use the same software and data. This ensures that all reports are consistent and accurate. By combining both, a company gains trust from outsiders and also gets useful insights to make better decisions for success.
Who Cares About Financial vs. Managerial Accounting?
External stakeholders like investors, regulatory agencies, and creditors use financial accounting information to evaluate the past performance and financial health of a company. Managerial accounting information is used by internal users, such as management, to make forward-looking, data-driven decisions about planning, control, productivity, and resource allocation. Also, users of managerial accounting include internal auditors who use the data to make sure that internal procedures are working well and to mitigate fraud risk.
The Bottom Line
The key takeaway is that financial and managerial accounting serve different target audiences and purposes. Financial accounting provides the standardized, past performance reports needed for external compliance and attracting investments. On the other hand, managerial accounting delivers the flexible, future-oriented insights that internal managers need to guide the company towards better efficiency and profitability.
Connect with a financial expert for assistance in creating a plan that can boost your business towards success.
Difference Between Financial Accounting and Managerial Accounting – FAQs
Q1: What is financial and managerial accounting?
Ans. The process of recording, summarizing, and reporting the financial activities of a company is called financial accounting. It mainly includes external stakeholders such as investors, creditors, and government authorities. In contrast, managerial accounting, also known as management accounting, addresses internal management by providing them with thorough financial and non-financial information for planning and decision making.
Q2: Is managerial accounting more difficult than financial accounting?
Ans. The complexity of managerial accounting and financial accounting depends on an individual’s interest and skills. For example, several individuals struggle with managerial accounting because it places a lot of pressure on analytical thinking and judgment instead of a strict set of rules.
Q3: Can a company use both financial and managerial accounting?
Ans. Yes, a company may and should use both financial and managerial accounting. The two accounting types are not mutually exclusive and together work to create a complete financial strategy. For example, sales data from financial reports can help managerial accountants improve production efficiency. A drop in profits, as shown in financial statements, may encourage managers to use managerial tools such as cost analysis to determine the source of the problem.
Q4: What are some similarities between financial & managerial accounting?
Ans. Regardless of their different goals, financial & managerial accounting have several fundamental common points. Both exist to provide important financial information to their users, though they use different strategies. Additionally, they use the same sources of information from the company’s financial activities, which include assets, revenues, and expenditures.
Q5: What are GAAP and IFRS?
Ans. The full form of GAAP is Generally Accepted Accounting Principles and IFRS is International Financial Reporting Standards. These two are major sets of regulations used worldwide to standardize financial reporting.