Why It Matters: Nature of Managerial Accounting

Gift basketsImagine that you have just been hired to manage a company that makes gift baskets. You have studied the financial statements for the past five years, which show that the company, GBS, Inc., has been losing money and borrowing heavily in order to stay in business. Your job is to turn this company around before it goes bankrupt.

How helpful will the traditional financial statements be in this endeavor? What kind of information do you think you will need? What strategies will be helpful for you?

You may find it helpful to create an overall budget and several more specific budgets, such as a sales budget and a production budget. In creating those budgets, you’ll need to know costs and revenues—and how those two are related to each other. You’ll probably want to know where you can cut costs and what effect that might have on overall operations. You also might want to know where to increase costs, such as in marketing or raw materials (higher quality baskets and merchandise might actually increase the bottom line). You’ll need staffing schedules and pay schedules and production schedules with cost data along with how many units the company can produce during a given shift. You’ll need to know product return rates and how many baskets, if any, are being rejected in the quality control process.

In addition to all this planning data, once you get your profit plan and budgets in place, you will need some kind of real-time monitoring system. By the time the year-end or even quarterly financials are checked and published, it’s too late to make adjustments to your plan. Even more importantly, you need some way to implement controls to ensure that production and sales are going according to plan—a way to monitor and control your strategy. Most managers are watching leading indicators, such as open sales orders—which help determine production volume— rather than trailing indicators, such as financial statements for outside users that show profit or loss for past time periods.

Eyes reflected in rearview mirror
Although your goal is to increase profits, you need to be watching the road ahead of you rather than steering by looking in the rearview mirror.

These are some of the reasons managerial accounting is so important to business and why it is an entirely different subject from financial accounting.