Managerial accounting vs. financial accounting: What works?

Managerial and financial accounting play pivotal but notably distinct roles in your startup’s financial success. Managerial accounting helps internal leaders make informed business decisions, while financial accounting is primarily about compliance with external reporting requirements, such as a prospective investor’s.

Understanding managerial accounting vs financial accounting is critical for startup founders as your business grows. For example, when new challenges arise, you must be able to articulate what they are and how they differ to hire the right kind of expert accounting help.

Let’s explore the meaning and significance of these two types of accounting in more detail.

What is managerial accounting?

In managerial accounting, financial data and analysis are utilized to support decision-making and achieve organizational objectives.

The process includes identifying relevant financial information, measuring it accurately, and using tools such as data analysis and interpretation to understand and communicate it to managers and improve spending habits.

Unlike financial accounting, which businesses use for external purposes such as public records and taxes, managerial accounting is only for internal use as a decision-making tool.

Financial advisors, like CFOs, utilize managerial accounting to aid decision-making.

This type of accounting goes beyond managing essential data like accounts receivable by offering reports, forecasting, analytics, and insight into a company's financials. Your team can use this data to develop strategies, set goals, and make decisions.

Examples of managerial accounting

A great example of how you can use managerial accounting is profit margin analysis.

Say your business, Startup X, offers an e-commerce product that sells for $20. Your cost per unit to make the product is $10, which leaves you with an operating margin of 50%.

This means out of every dollar you make from selling the product, 50 cents goes toward its production.

Another example of how managerial accounting can benefit startups is profitability analysis.

For instance, imagine Startup Y has two product lines, one for $20 and another for $50. By tracking both profits and costs on a product-by-product basis, you can better understand which products offer the most potential and whether it's best to focus on the higher-priced one or the lower-priced one.

If the cost of materials or labor increases and you don't raise prices, your profit margin decreases. Managerial accounting tracks and analyzes those changes to ensure that your product remains profitable.

Advantages of managerial accounting

Efficiently managing your finances and tracking your expenses come down to accounting and bookkeeping. Financial management is especially vital for startups, which are more likely to have volatile cash flows.

Managerial accounting is an accounting tool used to gain key insights about your finances by utilizing cost-related data. It offers several distinct advantages that are especially beneficial to startups.

Let’s explore these advantages below.

Informed goal setting

Managerial accounting helps you set and track progress toward those goals.

Marginal cost analysis, for example, allows you to track how output and costs change through a marginal analysis formula.

To calculate marginal cost, subtract the total cost change resulting from a shift in production, and divide by the difference in quantity. This analysis allows you to make pricing and production decisions that align with your goals.

Clarity in decision making

Managerial accounting provides your internal team with a clear picture of your company’s financials. A full view helps you make decisions based on accurate information and financial trends analysis rather than relying solely on guesswork to budget and forecast.

Improved problem-solving

Founders can use managerial accounting to help solve cash flow problems. Cash flow statement analysis is an accounting technique that looks at cash inflows and outflows to determine if the organization's spending is out of balance.

Cash flow monitoring helps you identify areas where you need to cut costs or allocate more funds for the organization to remain profitable.

What is financial accounting?

Financial accounting is a form of accounting that focuses on the accuracy, transparency, and presentation of your financial data. This type of accounting often follows strict guidelines for external use.

For example, startups may follow Generally Accepted Accounting Principles, the highest accounting standard in the U.S., set by the Financial Accounting Standards Board.

Business financial statements, such as your income statement (or profit and loss statement), balance sheet,  and cash flow statement, provide transparency to investors and stakeholders.

Examples of financial accounting

To understand how financial accounting can help internal and external stakeholders make decisions, consider a balance sheet vs. an income statement.

The balance sheet is a detailed report that breaks down the company's assets, liabilities, and equity. It provides an overview of the business's financial position at any given time.

On the other hand, the income statement, an example of financial accounting, presents information about revenues, expenses, and profit or loss over a specific period.

Investors will use this information to understand the company's financial performance and whether or not they want to invest in the business.

Advantages of financial accounting

Having accurate and transparent financial statements is vital for any business, but it is especially beneficial for startups. Financial accounting techniques allow current and potential investors to access financials that predict the organization's future performance. 

With this information, possible investors can determine whether they want to invest, and current investors can offer guidance regarding financial hiccups.  

Let’s explore more advantages below.

Demonstrate profitability

Ultimately, financial accounting demonstrates a business's profitability. When comparing expenses to income, investors can quickly identify if the company is making more money than it is spending. Analyzing how efficiently your business is running helps potential investors gauge its potential for success.

Achieve consistent financial record management

Consistent financial record management is critical for startups. Financial accounting can help ensure that all data entered into the system is accurate and up to date by allowing for easy comparison of current and historical financial data. 

If you use automated accounting software, you may be able to pull the data for a side-by-side comparison directly. Frequent supervision helps to minimize errors and oversights that could harm the company's financials.

Performance analysis

One of the most important aspects of financial accounting for startups is performance analysis. Founders can compare current revenue to past amounts through startup KPI reporting to determine whether or not your business is meeting its goals.

This helps you to track progress and make necessary adjustments so investors and shareholders can have confidence in the company's performance.

Financial accounting vs managerial accounting: How they work together

Financial and managerial accounting are distinctly different but closely related. Both require financial data for accuracy, and both provide insight into your startup’s overall performance. 

The number one difference between financial and managerial accounting is who is viewing the financial data. As already mentioned, reports from financial accounting are external facing. Reports and analyses from managerial accounting are for internal purposes only.   

Beyond this, how external and internal audiences use the data can also be similar but different in many ways. Here are some examples:  

Analytics  

Both types of accounting leverage analytics to provide financial data about the startup and its performance.

For instance, predictive analytics uses historical spending, statistical modeling, and profit-related data to anticipate future trends that you should plan for in your budget and operations.

Analytics can help identify future trouble areas that may harm profitability. This helps ensure the business is successful and can continue providing a return on investment for shareholders and investors.

Projections  

Financial and managerial accounting aid in creating startup financial projections. These predictions can help investors determine whether or not they should invest in the startup and inform founders of how their decisions today will impact the business later.

Financial clarity

Using financial and managerial accounting, founders can get a concise picture of the organization's health to make decisions confidently.

Financial accounting helps demonstrate profitability by tracking key performance indicators over time, while managerial accounting helps identify and anticipate problem areas through internal analysis.

Both methods provide founders with the data they need to ensure the company is on track to reach its goals.

Why should startups use financial and managerial accounting?

Founders often face uncertainty and risk when starting a business. Making the right decisions for your success can be difficult without a solid understanding of your financial performance.

By utilizing financial or managerial accounting, founders can gain clarity and insight into their funds.

While managerial accounting offers performance and operational metrics to internal stakeholders, financial accounting provides a comprehensive view of the company's economic structure and profitability for investors.

Combining both aspects can give founders valuable insight into their business and provide them with an edge to succeed in the competitive startup landscape.

Comprehensive financial management may seem out of reach, but implementing sound financial accounting principles can help your business stay in the black.