Management Accounting
Financial Reference Sheets
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Declaration
Please note:
All financial information shared in this document is fictional data that has been created for learning purposes. It is not representative of any true financial data for Vets for Pets or Companion Care. This reference sheet has been based on the initial ‘management accounting checklist’ created by the CMI, and hosted as part of Management Direct. Original content and information is, therefore, copyright 2017 Chartered Management Institute.
Future Practice Owner.
Management Accounting
Introduction
Management accounting is concerned with using financial information to assist in the internal management of a practice. It is different from financial accounting which provides financial reports to various segments of the public and to shareholders. This checklist is intended to provide managers with an overview of the scope of the work done by management accountants and the contribution it can make to the effective management and performance improvement of a business.
What is Management Accounting?
Management accounting is a practice that provides the management of a business with the information they need to make decisions. It encompasses performance management, strategic management and risk management.
Management Accounting Checklist
Understand the scope of management accounting
Management accounting seeks to address these three business areas:
performance management strategic management risk management.
There is of course, considerable overlap between these three areas. Although management accounting as a discipline and practice is distinct from financial accounting, it may use information produced in a business's financial accounts and a certain level of integration is required.
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Management Accounting
Management Accounting Checklist
The role of management accounting in performance management
Management accounting seeks to assist management performance through a process of reporting on all aspects of business activity. This will include reporting on: Sales - volumes sold, product mixes and prices Manufacturing efficiency - material usage, material prices, labour efficiency, labour rates and capacity usage Administration - overhead expenditure, departmental budgets and cash management.
The precise scope of a management accountant's work will vary from one organisation to another. In smaller organisations the financial accountant may also be responsible for the production of management reports. Two significant areas of a management accountant's responsibility will be product costing and budgetary control. Costing The elements of a product cost are: direct material, direct labour, direct and apportioned overheads. Some costs are variable in that they 'vary' with a level of activity such as production volumes and other costs are fixed and do not 'vary' with activity - rates for example. A management accountant might prepare product costs on a marginal costing basis and only allocate variable costs (direct material and direct labour) to the product.
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Management Accounting
Management Accounting Checklist
Example of marginal costing
Example of marginal costing:
Marginal costing clearly demonstrates the break-even-point (BEP). In this case the business needs to produce a contribution of £20,000 to fully cover the fixed costs and 'break-even'. Alternatively a management accountant might prepare costs on a fully absorbed basis and allocate the £20,000 of fixed costs to the products. One method of absorption costing is the fully integrated standard costing system which is used in manufacturing companies. This method of costing uses standard costs, material usage, labour rates and times for product costing and produces reports that show variances for each of these categories that enable management to take corrective action or amend plans. Another method is Activity Based Costing (ABC) whereby costs are first assigned to activities and then to products.
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Management Accounting
Management Accounting Checklist
Budgeting
Budgetary control falls within the performance management and control aspects of management accounting. A budget is a financial evaluation of a plan against which actual expenditure can be compared and monitored. A typical budget report will show actual costs against budgeted costs and provide an explanation for any variance.
Variance analysis is a technique used in management accounting to analyse variances against budget.
Example:
Note: Although the current total variance is 0 it will be (2) adverse once the planned travel is undertaken. This variance is due to an additional staff member (additional outlay) and a pay increase above that budgeted (rate).
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Management Accounting
Management Accounting Checklist
Performance Indicators
In addition to costing and budgeting performance management is concerned with all aspects of a business's activities and a management accountant will produce reports on any area that is relevant to the business. Key performance measures will be identified and reported on a management dashboard. Some key performance figures include:
Return on capital employed in the business Dividend yield and cover. Return on capital employed in the business Dividend yield and cover.
Capacity usage Stock turnover Expenditure
Sales value Sales volume/mix Gross margins Market share Manufacturing costs Material price and usage Labour rates and efficiency
variance analysis Cash levels and liquidity Debtor's days Gearing ratio (loans
to equity) Net profit
Business managers should identify the most important performance indicators that are needed on a daily basis, and ensure that the management reporting system is capable of providing the information required. Three of the most common daily internal indicators are cash, sales and gross margin. These along with external information such as share price will always be closely followed by the chief executive. It is always important to identify, collect and take relevant information into account when making business decisions.
Future Practice Owner.
Management Accounting
Management Accounting Checklist
The role of management accounting in strategic management
Management accounting provides information to guide the strategic direction of a business. This will include helping a business decide on which potential investments to pursue, setting selling prices, marketing strategy, funding, dividend policy and financial strategy. The most important interfaces between management accounting and strategic management are discussed below.
Setting selling prices
Selling prices are determined by external market forces. However, internal management accounting information will enable decisions to be made concerning which products to sell and how profitable they will be. It will also help with product sales/mix decisions. The process for setting selling prices involves a comparison of market prices obtainable with internal costs of sales. This will enable decisions to be made regarding the whole spectrum of internal processes from buying to manufacturing and distribution. Pricing strategies are a part of business strategy and management accounting information will help identify the benefits of each strategy.
Investment appraisal
Management accounting can provide a process for analysing and deciding upon various investment decisions. The most important thing to remember in any investment decisions is relevant cash flow. It is important not to get confused by information and values that are simply not relevant. Management accounting will use a number of techniques to evaluate and prioritise potential investments. These techniques will include pay-back period, return on capital, accounting rate of return, discounted-cash-flow, the internal rate of return and capital rationing techniques.
Future Practice Owner.
Management Accounting
Management Accounting Checklist
The role of management accounting in strategic management
Make or buy decisions and lease or buy decisions
Whether to make a product internally or buy it externally is a common decision that organisations have to make. Another is whether to lease or buy. These options will invariably have different cash flow timings and taxation considerations. Then there are the questions of capacity and opportunity costs. Management accounting can extract and obtain the relevant information and prepare the calculations (using discounted cash flow and other techniques) to enable a correct decision to be made. It is important to include other factors than financial returns for decision making, for example lower costs for items bought from overseas in large quantities requiring long lead times may be a high risk compared to more expensive items bought or made locally with much shorter lead times.
Gearing and the cost of capital
How a practice is to be financed is a strategic decision. Should it have high gearing or low gearing? This decision requires an understanding of the cost of capital - the return that a practice has to pay to gain and retain funds from investors. Investors will assess risk. The management accountant should be able to calculate the weighted average cost of capital (WACC), the marginal cost of capital, the cost of ordinary share capital and use the dividend growth model and capital-asset pricing model (CAPM). A detailed explanation of these concepts is not possible within this short check list but managers should be aware of their use and how they are required in both strategic financial decisions and used within discounted cash flow calculations to provide a discount rate.
Future Practice Owner.
Management Accounting
Management Accounting Checklist
The role of management accounting in strategic management
Dividend policy
Dividend policy can have a huge impact on the financial health of a company. It affects liquidity, the cost of capital and the market value of shares. Retained earnings are a most important source of finance. A balance needs to be struck between shareholder and market expectations and financial efficiency. Management accounting will help arrive at an optimal solution for dividend payments.
The role of management accounting in risk management
Management accountants are trained in analysis and control and have an important role to play in the identification and management of risk. They can assist managers in prioritising business risks, evaluating them and determining the extent to which they can be controlled or mitigated. Risk is inherent in all business activities and, generally, the greater the risk the greater the potential return or loss. Some risks are not at all obvious and can catch a business by surprise. Management accounting provides a series of tools and techniques that help identify and evaluate risks. A risk-based approach to managing an enterprise (such as ERM - Enterprise Risk Management) attempts to provide an explanation of risk to various stakeholders in an organisation by identifying events that might occur in the pursuit of organisational objectives and assessing their probability and financial or other impact.
Future Practice Owner.
Management Accounting
Management Accounting Checklist
The role of management accounting in risk management
Once risks have been prioritised then control can be exercised. However, some risks are less easy to control than others. Some risks may be neither controllable nor avoidable. Management accounting provides a framework for the classification and better understanding of risk. Some risks may be very likely to occur but only have a low impact on business performance or results. Other risks may be less likely but have a much greater impact on the business. Some risks could be highly probable and also have a high impact on results. Risks can be plotted against their probability in order to determine where most management attention should be focused in order to avoid or limit damage.
Potential Pitfalls Managers should avoid:
solving the wrong problem really well getting 'bogged down' with irrelevant information using the numbers without doing a reality check complex spreadsheets with embedded errors
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