Accounting is the process of recording financial transactions in the accounting records of an organization. These transactions are aggregated together at the end of a financial period and presented as a set of financial statements, also known as ‘accounts’.
The vocation of accounting takes its name from the ‘statement of account’ which a trading merchant would provide to their financial backers upon their return from a voyage. As external shareholders began to finance a wider variety of companies and operations, those companies would also share their accounts with their beneficial owners. A set of accounts can allow management to demonstrate that they have acted as responsible stewards of the investors’ capital.
Organizations produce accounts in different formats and using different methodologies. This variety is driven by the differing needs of the stakeholder groups of an organization. These stakeholders could include:
- Shareholders and bondholders
- Domestic and international tax authorities
- Government and its organizations
- Banks and other financial institutions
- Trading counterparties, such as customers and suppliers
- Employees and workers
- Wider civil society
These differences have given rise to two types of accounts – financial accounts and management accounts. We will outline the major points of differences between these in this article.
Definitions and meanings
Financial accounts
Financial accounts are designed to provide an accurate and comparable financial summary of a quarterly or annual trading period, together with a snapshot of the balance sheet of the company at the period end.
The financial performance of a business is summarized in an income statement, which shows the total revenues and expenditures of a business. An income statement culminates in the net profit or net income of a business, which is stated after corporate taxes are deducted. The net income of a business is generally available for distribution to shareholders as a dividend, at the discretion of management.
The balance sheet gives a picture of the assets and liabilities of a business at a precise reporting date. This can reveal financial risk, or significant judgements made by the chief financial officer (CFO) which could impact future financial performance.
Financial accounts may also include a cash flow statement, which provides an insight into the real cash inflows and outflows of an organization. This can paint a dramatically different picture of an organizations performance, particularly if the business is heavily acquisitive or deals with slow-paying customers.
Financial accounts are produced under the supervision of qualified accountants to a strict set of accounting standards. The accounting standards adopted by a company or charity will depend on the jurisdiction of its headquarters and whether the company is publicly listed on a stock exchange. Small businesses will usually apply the lightweight ‘Generally Accepted Accounting Principles’ of their local country, known as local GAAP for short.
Large or publicly listed businesses are expected to comply with the International Financial Reporting Standards, known as IFRS. These onerous requirements are embraced by the majority of listed groups worldwide. The consistency of accounting methodology used by listed groups allows analysts to make meaningful comparisons between the results of a business and its foreign competitors.
Management accounts
Management accounts are internal reports and spreadsheets which communicate vital financial information to the executive management team throughout the year. The vast majority of companies produce management accounts on a monthly basis. These management accounts display the current month and year-to-date position of the business. Comparisons against recent forecasts or the annual budget allow management to see whether the business is exceeding or disappointing against previous expectations.
Management accounts have no officially prescribed format; they are produced in line with internal conventions and accounting policies. Therefore, the level of detail and type of information included will vary depending on the needs and preferences of the leadership team.
Management accounting information will be used by the chief financial officer (CFO) or finance director to provide an update to the board of directors during monthly or quarterly board meetings.
This information is a key input into the strategic decisions and approvals made by the board, such as
- Proposals for employee recruitment
- Financing new business acquisitions
- Dividend payments to shareholders
- Annual pay reviews & bonus payouts
Difference between financial accounts and management accounts
Five key points of difference between financial accounts and management accounts are as follows:
1. Stakeholders
Financial accounts are published in the public domain and can be read by a wide variety of stakeholders. From prospective investors to journalists and politicians, financial accounts will be scoured by friendly and unfriendly eyes. Therefore, they are subject to rigorous internal review and businesses rarely disclose more than is mandated by regulation.
Management accounts, in contrast, are prepared and distributed internally to select members of management. The preparers of management accounts can therefore tailor them in response to specific requests from management.
2. Frequency of preparation
Management accounts are usually prepared on a monthly basis. This level of frequency provides management with the opportunity to read and act upon their contents, delivering change in the business. This allows management to respond in a proactive manner to financial concerns such as reducing gross margin or an increase in exposure to bad debts.
Financial statements are prepared on a quarterly or annual basis, depending on the regulatory environment. Financial statements are primarily produced to satisfy regulators, rather than to generate information for the board. Therefore, they are rarely prepared more frequently than is legally required.
3. Disclosure requirements
Alongside the primary financial statements such as the income statement, balance sheet or cash flow statement, financial accounts also include financial disclosures. These are extra pieces of information that allow the users of accounts to understand the composition or nature of balances or items of income or expenditure in more detail.
Examples of financial disclosures include:
- The remuneration of the CEO
- A breakdown of revenue by geographical region
- Explanation of the conditions attached to debts and loans
Financial disclosures improve the transparency of financial statements and facilitate good comparative analysis because they allow analysts to spot one-off or unusual items which would otherwise be ‘hidden’ within a wider caption in the accounts.
Financial accounts contain significantly more financial disclosures than management accounts, which can sometimes contain none beyond some supplementary headcount data.
For listed businesses, these accounts contain vast quantities of disclosure. As an illustration, the 2020 Annual Report of BP plc is 365 pages long. In this document, the primary financial statements consist of 5 pages, with the remaining 360 pages being classified as additional disclosures. This length is driven by the number of disclosure requirements of IFRS.
Local GAAP typically contains a lighter framework of disclosure rules, although the extent to which this is true varies between jurisdictions. The typical length of financial accounts published under UK-GAAP by a large UK company is 20 – 40 pages, with 4 pages devoted to the primary financial statements.
4. Production deadlines
Management accounts are produced under an accelerated timetable to allow management to respond to the results and take action to improve business performance in real-time.
Financial accounts may be produced over several months. In the UK, for example, The Companies Act 2006 (s442) states that the period allowed for filing accounts is nine months after the end of the relevant accounting reference period for private companies. For public companies, this is six months.
5. Accounting standards
Financial accounts are mostly prepared in line with IFRS or local GAAP, which are set out in accounting books. Management accounts can be prepared under whatever accounting policies are chosen by management. The emphasize of management accounts is not comparability between competitors, but comparability between periods. Reduced to its simplest explanation, management accounts show management whether performance is improving over time.
It is, therefore, sometimes more important for management accounts to be consistently produced with prior months than be objectively accurate. Accuracy carries a financial cost, in the form of the size and seniority of the accounting team which prepares them. There exists a trade-off in the accuracy of management accounts, and the cost of preparing them.
Conclusion
Accounts are prepared with the end-user firmly in mind. They are expensive to produce and, therefore, an efficient set of accounts will provide only the most useful and legally required information.
To this end, financial accounts and management accounts look very different, reflecting their different users.
