Areas of Accounting In Business
Financial Accounting, Managerial Accounting, and Cost Accounting
Accounting and finance serve two different functions in a business. Accounting is the recording of financial transactions for informational and reporting purposes. Finance is the use of accounting information to make investment and monetary decisions required to operate and grow a business.
There are three areas of accounting business owners should become familiar with. Financial accounting is used for reporting and financial ratios. Managerial accounting deals with finances involved in managerial decisions and cost accounting is associated with costs of production.
The Federal Accounting Standards Board is a private entity whose goal is to guide businesses in their accounting procedures and practices, by publishing guidelines. These guidelines are known as Generally Accepted Accounting Principles (GAAP), which attempt to standardize the way businesses record and report finances.
Publicly traded companies are required to follow GAAP when preparing their financial reports for reporting or for investors.
Financial accounting is the area of accounting that stakeholders—any party with a vested interest in the business—are most interested in. These parties include the Securities and Exchange Commission (SEC), stockholders, prospective stock buyers, business owners and boards of directors.
Financial accounting generally takes the form of a balance sheet, income statement, and a statement of cash flows. These statements are all generated from a business' accounting activities, such as general ledgers and journals. Ledgers and journals are accounting tools used to record financial transactions.
The three statements provide the information used in calculating financial ratios used in an analysis of a firm's financial performance. There are different types of financial ratios in financial analysis.
Liquidity ratios, such as the current ratio, show how quickly a business can convert assets into cash in the short term. Leverage ratios, such as debt to asset or debt to capital, are used to demonstrate how a business uses debt to finance its operations. Companies use different methods to finance operations, such as debt (loans) or equity (offering stocks or other investments).
Efficiency ratios are useful in demonstrating how a company uses its assets and finances. An example of efficiency ratios is the asset turnover ratio, which measures the ability to turn assets into cash through sales.
Managerial accounting uses the same information from the accounting documents as financial accounting. This form of accounting differs in that the ratios and analysis from accounting documentation are used to make managerial decisions.
Managers use financial information for forecasting methods such as margin analysis, risk management, and cost-volume-profit analysis to generate the most accurate forward-looking information as possible. This information is used for making future decisions involving operations, product offers, pricing, or marketing plans.
Managerial accounting measurements are usually kept in-house due to the sensitive nature of the information.
Cost accounting and managerial accounting are used by management to make decisions. Sometimes they are considered to be the same. However, cost accounting is used to analyze costs incurred by processes.
Cost accounting takes variable, fixed, indirect, direct, and operating costs into consideration for cost metrics. Some cost metrics are cost performance (an efficiency measurement of costs) and actual cost (how much the project or product actually cost).
Variable costs are costs that fluctuate with production, such as raw materials or energy. A fixed cost example could be rent. A direct cost is a cost directly related to production such as labor.
An indirect cost is indirectly related to production, such as business insurance. Operating costs include the cost of goods sold or any other expenses generated by operating.