The role of a manager is of utmost importance for every organisation that wants to survive in the new-age business environment. The success of every organisation is proportional to the calibre of the managers and their workforce. The capability of managers to utilise the business resources determines how effectively the organisation will reach its goals.
The reason behind every large-scale wealth creation is adequate planning, organising, directing the course of action, and control by the managers. Managers can exercise their duties effectively only if they are conscious of internal and external information that drives the enterprise.
Managers can achieve this through various financial and managerial accounting tools, which assist managers in coming up with quantitative data. This quantitative information determines the further course of action that is in the enterprise's best interest.
The principal variance between the two branches of accounting is the end-user of the information. Management accounting intends to report internal data to the managers to make rational business decisions. While financial accounting primarily aims to provide financial information to external stakeholders of information like bankers, shareholders, investors, etc.
Financial accounting is bound to follow standards such as GAAP (Generally Accepted Accounting Principles). All enterprises with a stake in the masses must draft their financial records following the GAAP. A set standard for presenting financial statements imparts uniformity to the financial information, making the financial report comparable and inviting well-informed decisions from its external stakeholders. Moreover, drafting financial statements conforming to GAAP keeps the way clear for the enterprises to meet their debt agreements often required by the financial institutions extending credit.
Since management accounting intends to report to the internal users of the information, the management can customise it to suit the end-user specifications.
It may differ considerably per the company's expectation or a specific department within a company. For instance, managers concerning the production department expect financial information based on the percentage of units manufactured during the financial year. Similarly, the HR department manager may prefer to seek a graphical representation of the employee's salary.
The procurement department manager would like to seek data on the usage pattern of raw materials to ensure that the supply is continuous. Through management accounting techniques, individual departments can avail crucial information in a format that suits their needs. Management accounting encompasses many divisions, like cost accounting, budgeting, financial ratio analysis, forecasting, etc.
Product costing is a method through which an enterprise determines the total costs incurred in producing a utility. Costs incurred may be classified into sub-categories: variable, fixed, direct, and indirect. Through product costing, managers can measure and allocate overhead costs to the production cost of goods and services.
Managers may designate the overheads to the product's value based on volume manufactured or other activity drivers like machine hours, a floor area or labour hours. The managers can arrive at the total cost by summing up the direct and indirect expenses (overheads), which shall differ throughout the various production steps.
Marginal cost is the variation in the total cost of producing a good when the quantity is increased by one. Marginal costing is a beneficial tool in profit planning. It helps to determine the level of profitability at various production levels. Break-even analysis and profit-volume ratio are the most valuable techniques under marginal costing.
The break-even analysis helps plan the production level by portraying how many units of the products the enterprise must sell to cover the variable and fixed costs of manufacturing the product.
The profit-volume (P/V) ratio determines the relationship between the contribution and sales expressed as a percentage. One could arrive at the contribution figure by deducting fixed costs from the sales. The P/V ratio also measures the rate of change in profit with a change in sales volume.
The underlying advantage of computing the P/V ratio is that it helps measure the profitability of a product, production centre, or process so that a brief assessment can be made for the requirement to carry on the production process.
With cash flow analysis, the managers can assess the impact of the core decisions on the business's cash flows (inflows and outflows). For instance, if an organisation is thinking about purchasing an asset. The organisation has two main options: either own it with an outright cash payment or get it financed. With a cash flow analysis, the managers can compare the cash outflows of outright purchasing versus bankrolling the asset at prevailing interest rates over a while. Such a detailed analysis of the effects of cash outlay on the financial position helps make a well-informed decision.
Since most corporates draft their accounting records on an accrual basis, it becomes difficult to detect the cash impact on a financial transaction. The managers may execute working capital management approaches suitable to maintain optimum cash flows. This prudent practice of the managers helps to meet the contingent cash requirements of the enterprise. Such practice also ensures the reserve of enough liquidity to meet short-term commitments.
Inventory turnover measures how fast an enterprise can sell its inventory (products) for a specified period. A lower inventory turnover ratio implies that the enterprise is weaker in sales, or the reason might be overstocking the inventory. A lower inventory turnover ratio indicates a poor selling line or there is a requirement for the marketing campaign to boost product sales.
A higher inventory turnover ratio indicates boosted sales or insufficient inventory to cater to the product requirement. An increase in sales is desirable, while inadequate inventory symbolises a significant risk to business activities.
An enterprise's rate of selling products is a decisive measure of its performance. An increased inventory turnover ratio indicates that retailers are clearing the stock in no time and are performing outstandingly. Conversely, a lower ratio indicates that a retailer cannot sell the stock. In turn, holding the stock for longer on its premises increases its holding cost. Thus, reducing the retailer's margin.
Using borrowed capital to procure assets and increase the return on investments is called Financial Leverage. Through a detailed analysis of the debt and equity figures in the balance sheet, one can use the financial leverage in the most optimum manner. Return on equity, debt-equity ratio, and return on invested capital are common financial ratios that determine how the application of borrowed funds works.
Under the cash method of accounting, financial transactions get recorded into the books only upon cash transfer. Under this method, the revenue gets recorded upon receipt in cash. On the other hand, the expenses get recorded only when the payment gets settled in cash.
Keeping an eye on the cash flow trail is also easy, as the transactions get recognised solely as cash inflows and outflows. The cash method being an effortless approach is not popular these days. The cash method of accounting is still in effect at smaller business houses.
The major disadvantage of the cash basis of accounting is its tendency to exaggerate the financial health of an organisation. An organisation with a cash basis of accounting might hold an impression of being cash-rich even if its account payables exceed the amount of cash available to the organisation. An investor might get tricked and assume the company to be profit-making, but contrary to this, it is carrying out a loss-making business.
Accrual accounting involves the recording of the transaction on its occurrence. The accrual method is considered the most effective and accurate technique for recording financial transactions. Moreover, this method of accounting is effective for companies having a public stake.
Unlike the cash basis, where a transaction gets recognised if there is an exchange of cash (receipt or payment), the accrual basis is advantageous because it records the financial transaction as soon as it occurs, irrespective of whether the exchange of cash has taken place or not.
The accrual basis of accounting also includes accounts payables and accounts receivables. With adequate information about the payables and the receivables, the accrual method depicts a much more realistic picture of the profitability in the long term.
For instance, Mr A runs a business engaged in the trading of automobiles. If Mr A manages to sell a car worth INR 6,20,000, here are the two possible scenarios.
Under the cash basis, Mr A would not record the transaction until the payment gets settled in cash, i.e., either the customer pays him in cash or cheque.
Under the accrual basis, Mr A would record the transaction immediately because he secures the right to receive the payment upon delivery of the car, even if the payment is received weeks or months later.
To sum up, accounting is both a science and an art that records, classifies, and summarises financial transactions. It is also a product of structured knowledge based on accounting principles. It is up to the stature of modern-day managers to make use of accounting techniques and knowledge to gain insight into the profitability and financial health of the venture.