Streamline your business and make informed decisions with managerial accounting.
As a small to midsize business leader, you may feel that you’re lacking the financial insights and data analysis to streamline your operations in a way that makes your business more agile and competitive in the market. However, like 44% of other decision-makers, you may not have the bandwidth to tackle this accounting problem yourself.
If this is the case, a managerial accountant can provide the information you need to pinpoint problem areas within your business, or to improve areas in which bottlenecks (financial or otherwise) have been found.
What is managerial accounting?
Managerial accounting is a type of accounting that focuses on giving decision-makers the financial information and analysis they need to guide their organizations in a more informed direction.
A managerial accountant is a valuable asset because they provide insight into many key details that management may otherwise miss, such as how to invest funds, which revenue streams are the most productive, and which elements of overhead are simply too costly to maintain.
To illustrate how managerial accounting can be a valuable solution, imagine you run a small business that sells products mostly made in China. You notice your company has been running short on cash and ask a managerial accountant for help. The accountant takes a look at your records and reveals the following issues:
Your shipping costs have significantly increased your overhead.
Delays at overseas shipping ports have resulted in more customers choosing to do business with companies that work with domestic providers.
Some of the Chinese providers you’ve been dealing with have increased their prices significantly over the past year.
Your managerial accountant uncovers critical issues that, by making some decisions around your supply chain, you can solve within a few months.
Managerial accounting vs. financial accounting
Managerial accounting and financial accounting are different in that financial accounting doesn’t necessarily involve providing business intelligence to decision-makers. A financial accountant can simply create clear reports of a company’s financial performance and disseminate them to those in charge.
On the other hand, a managerial accountant completes their work with the primary objective of discovering ways to help the business perform better. After surfacing crucial financial insights, the managerial accountant then provides this to business leaders in an easy-to-understand report.
For example, a financial accountant may tell you how much different departments make and how they compare. Using the same performance data, a managerial accountant may set up key performance indicators (KPIs) for each department, with the objective of getting the underperforming departments on par with those that are meeting goals.
Managerial accounting methods
Managerial accounting isn’t about taking numbers and generating random advice. There are specific methods used to produce the kinds of insights that deliver value. The pillars of managerial accounting include:
Cost accounting
Cost accounting involves analyzing inventory and the cost of making products. With inventory valuation and product costing, you use managerial accounting to perform cost trend analysis as part of your capital budgeting strategy. When your managerial accountants recognize a trend that could negatively impact your bottom line, they present it and offer suggestions for controlling costs.
Capital budgeting
A managerial accountant uses capital budgeting to choose the best ways to generate and invest capital from a long-term perspective. Your capital budgeting strategy may involve opting for more stable, predictable investments that provide modest yields over more volatile investments with higher risk/reward ratios. Some companies may opt for the opposite or use a mix of the two approaches.
Capital budgeting also involves deciding how much money to invest in day-to-day business projects. It takes into consideration how much projects cost, how these expenses may change over time, and ways to mitigate any potential cost overruns.
Trend analysis
Trend analysis and forecasting are central to managerial accounting because they provide visibility into what may happen in your business’s future, particularly if current conditions remain the same.
For example, an accountant for a manufacturing company may notice a long-term trend of the company spending more and more on paying their factory staff. For instance, they may be outpacing the average pay in their sector by 15% per employee. Because this isn’t sustainable in the long run, the accountants may advise more modest pay increases for the next five years.
Cash flow analysis
Cash flow analysis centers around estimating how much cash flow you expect each investment to generate. You take into consideration how much investments are currently generating, factors that may impact future performance, and what you can do to boost cash flow over time.
Returning to the manufacturing example from above, a cash flow analysis may reveal that the current hiring and training system costs, on average, $13,000 per person. This is dragging down your cash flow and could negatively affect your business’s viability down the line. Even though the company generates adequate revenue to support current operations, the incoming cash gets drained by these expensive onboarding costs.
To prevent future cash flow issues, your managerial accounting team may suggest that you conduct group training instead of more expensive, individual ones. In this way, you may be able to reduce your onboarding expenditures by 25%.
Margin analysis
Managerial accountants leverage margin analysis to look at sales revenue and the cost of goods sold (COGS) side-by-side to assess profitability. In this way, they use margin analysis to ensure “high” sales figures don’t paint a false picture of business performance.
For example, to calculate sales margins, you divide your gross profit by net sales revenue, then multiply by 100 to get a percentage. So if your gross profit is $100,000 and net sales revenue is $200,000, your sales profit margin would be $100,000 / $200,000 x 100 = 50%.
Using margin analysis, you may then decide to reduce your cost of goods sold to the point where your gross profit is higher, say $120,000, instead. Then your sales margin improves to $120,000 / $200,000 x 100 = 60%.
Constraint analysis
Constraint analysis focuses on pinpointing factors that are preventing a company from reaching its financial goals. Once you identify a constraint, you calculate its impact, figure out ways to mitigate it, and perform a cost-benefit analysis to see if your mitigation would have the impact you’d like.
For instance, let’s say a business spends $45,000 a year in travel expenses for salespeople to meet with new clients around the world. In these meetings, your sales reps showcase your offering, entertain potential and existing clients, and close lucrative deals.
But using constraint analysis, your managerial accountant reveals that this prevents you from hitting your short-term margin goals. They then suggest that your sales staff conducts more meetings using video conferencing and reserve face-to-face meetings for only the biggest clients.
Inventory turnover analysis
Inventory turnover analysis aims to ascertain how efficiently a company uses its inventory to generate sales. The foundation of inventory analysis is the inventory turnover ratio, which is calculated like this:
For example, suppose your cost of goods sold for the year is $800,000, and your average cost of inventory is $200,000. That means your inventory ratio would be as follows:
$800,000 / $200,000 = 4
In other words, you turn over your inventory four times a year. If you were to increase your inventory turnover ratio to five, that would mean you’d be turning your inventory over five times a year—or 25% more efficiently.
Inventory turnover analysis is important because the lower your ratio, the longer you’re holding inventory, and this may indicate:
Inefficient sales processes
Ineffective marketing that’s not delivering customers quickly enough
Over-spending on inventory storage and management
But by using inventory turnover analysis, your managerial accountant can help you troubleshoot these issues.
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What are some managerial accounting examples?
Managerial accounting techniques can add value to a business, and the examples below show a variety of ways in which this is true.
Example #1
Suppose a retail company’s purchasing manager sees a hot new item that’s been selling well in another nearby town. They want to present this to senior management as a new item to feature in the company’s retail outlets. They decide to consult with the managerial accountant first.
The managerial account factors in the cost of acquiring each item, including purchasing, shipping, and the expenses associated with a marketing campaign to generate interest. The accountant then uses these numbers to calculate the cost of goods sold and a projected sales margin.
The numbers don’t look good. The sales margin is at least 50% worse than all other products. So the managerial accountant advises the purchasing manager to put this idea on hold—at least until they can identify a way to get the COGS down. This saves the purchasing manager embarrassment and prevents the company from investing in a product that would generate relatively low returns.
Example #2
A hiring manager really wants to bring on another salesperson and wants to pitch the idea to a department head. But the manager doesn’t know how to quantify the value of the new hire.
So they go to the managerial accountant, who figures out how much each new employee earns the company over the course of two years—both from a gross and net perspective. The numbers look good. Each employee produces, on average, $38,000 for the company after factoring in expenses.
Armed with this data, the hiring manager is in a better position to argue for the new hire.
Implementing managerial accounting into your business
Using the seven methods outlined above, a managerial accountant can add significant value to your business. Of course, the benefits extend beyond these methodologies. A managerial accountant can be a valuable business advisor, quantifying the reasons behind decisions and guiding your company to a more profitable future.
If you’re looking to hire an accountant that specializes in managerial accounting, your next step is to use the resources below to make a more informed decision: