What you do and what you tell people you do should be different things. Not because you should be lying about what you do, but because what you do is complicated and specific. What you tell people is simple and general. Management accounting is the day-to-day of accounting and is what most small businesses think of when they think about their finances. Financial accounting is what you show your banker or inventors.
The distinction between the two accounting methods can be boiled down to this – the bank doesn’t care that Joe bought the expensive toner, you do.
If you can only manage one kind of accounting, management accounting is the way to go. The goal of management accounting is to give you the information about your business that you need to make better business decisions.
You want to know where your cash is going, how much more you’ll have coming in, and what you can do to make more money. Management accounting gives you the tools to make smarter decisions about the future of your business.
Basically, management accounting is going to help you build a valuable budget. You can build these on a daily, weekly, or yearly basis. If you decide you never want to dive into accounting, you can just never do it.
I do not recommend this option, but no one can make you take part in management accounting.
Financial accounting is usually foisted upon you. Investors and bankers need this information, and in many cases, you’ll be legally required to provide it. Financial accounting is very regimented, being overseen by regulatory bodies, like the SEC in the USA.
With financial accounting, you’re explaining where all the money went. You’re looking back at the previous period, organizing everything you did with your cash, and presenting it all in a concise format.
A great example of financial accounting can be found in publicly traded companies’ annual 10-K filings – here’s Coke’s, as an example. About fifty pages in, you’ll get a summary of Coke’s fiscal 2014 income. It’s broken down into a few classic lines, like revenue, costs, gross margin, etc. In the US, the SEC mandates using generally accepted accounting principles (GAAP) for this reporting.
If you’re company isn’t beholden to anyone, you can probably – talk to your accountant – skip financial accounting. In actuality, when tax time comes around, you’ll basically be building these reports to send off to the IRS anyways.
Why do both?
If you want your business to thrive, you should be doing some management accounting. Let me rephrase that – if you want your business to continue existing, you should be doing some management accounting. That should be the bare minimum for a business to stay afloat. You have to know what money you’re spending and what money you’ll have to spend.
If you’re already doing the mundane (tracking and predicting) small business accounting, I would suggest trying financial accounting on for size – even if it’s only once a year.
First off, you’ll save yourself time and money when tax time rolls around if you can simply hand off these readymade reports to your accountant. As I said, the IRS forms required for small businesses replicate most of the information you’ll be reporting on.
Financial accounting is like a mirror that reflects how other people see your business. You don’t have to agree with the reflection it shows you, but you should at least know what that reflection looks like. Amazon’s CEO, Jeff Bezos, is a great example of a businessman who disagrees with the picture painted by financial accounting, but who has reasons to explain why he disagrees.
Bezos rejects the classic earnings per share metric that most investors use as the gold standard for success. Instead, Bezos believes that Amazon should be maximizing its free cash flow per share. It doesn’t really matter what those terms mean or why they’re different, what matters is that Bezos uses GAAP reports to understand how others see his business and explains to them why he’s doing it a different way.
That practice, of justifying your actions, can lead you into a whole new world of insights. By trying on financial accounting every once and a while, you’ll get a whole new view of your company.
Header by Rachel Wille
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