In its most basic form, management accounting allows a business to control its operations and take informed decisions in line with its performance objectives. For small and growing businesses, management accounting is a way to ensure that the business stays within its means as it grows.
Prepare the budget
Cost benefit analysis
Take the right decisions
Design a suitable information system
Budgeting is the starting point of sound management accounting. Budgets directly contribute to performance management by providing concrete targets against which actual results can be compared, and corrective measures can be developed accordingly.
A simple budget can often result in anticipating and avoiding costly mistakes. Without a budget, an organisation will lack direction and risk being inefficient and ineffective.
Under management accounting, preparing a budget for each business segment is a good practice as it allows the business to position itself, track performance of different divisions/departments and take business decisions accordingly.
To help you prepare your first budget, you can download, as a guide, free business budget templates. Every business is different, your budget will be based on your business activity and requirements. Free business budget templates are available on Smartsheet, Vertex42, or Microsoft Office.
A cost benefit analysis is a process by which organisations analyse decisions, systems or projects to determine the value for intangibles. Managers will carry a cost benefit analysis to measure all potential costs and profits their company may generate if they undertake a specific project. This helps to determine whether the project or decision is financially feasible or not.
The first step to begin a cost benefit analysis is to draw a list of all the costs and benefits linked to the project or decision.
Costs can be classified by function, by element or by nature.
- By function, costs can be split into cost of sales (production costs), distribution costs (selling and distribution expenses), and administrative costs (head office costs, IT support and HR support).
- Classifying costs by elements would cover the three basic inputs for any manufacturing set-up: materials, labour, and other expenses such as overheads (electricity, depreciation, rent and other charges).
- Classifying costs by nature– direct and indirect – would be another way of accounting for costs from a control perspective.
Benefits should include all direct and indirect revenues as well as intangible benefits. The analyst would apply a common unit of monetary measurement to all items on the list, paying particular attention not to underestimate costs or overestimate benefits.
The final step is to compare the results of the aggregate costs and benefits quantitatively to determine if the benefits outweigh the costs. If so, then the rational decision is to go forward with the project. If not, the business should review the project to see if it can either increase benefits or decrease costs to make the project viable. Otherwise, the company shall not go forward with the project.
Managers must take many decisions on an ongoing basis, for example: they have the three main questions of How, When and What to produce? Indeed, it may not be wrong to state that decision-making is the focal point of management accounting.
In management accounting, it is useful to classify decisions making as strategic or tactical.
Strategic Decisions: Strategic decisions are broad-based, qualitative decisions which include or reflect goals and objectives.
Tactical Decisions: Tactical decision making are short-term decisions where tactics tend to be changeable. It consists of choosing among alternatives to reach a particular point or the desired end.
Example 1: Ahmad, the sales manager, accepted a special order for less than the normal selling price. Why? Simply, to utilise idle capacity and increase the year’s profits.
As a start-up or SME business, you should always be cautious with tactical decisions. Even when we said tactics are short-run in nature, they can have long-run consequences.
Example 2: Ahmad’s immediate objective is to reduce the cost of making toothpaste which is his main product. To do so, he decided to produce the toothpaste cap instead of buying it from suppliers.
This tactical decision may be a small portion of the overall strategy of establishing a cost-effective mechanism for his SME business. Thus, tactical decisions are often small-scale actions that serve the strategic goal of the business.
Management accounting primarily centers on tactical decisions. Qualitative decision also plays a great role in good decision making. The quality of decision making depends on the quality of the financial information intended for various levels of managers. And, as the business grows in complexity, managers need more and more information with more details. Without enough and detailed information and explanation, it is not possible for managers to lead the enterprise in the desired direction.
Your GroFin Investment Manager can assist you in evaluating your current management accounting systems and in putting a more efficient reporting system in place. Monthly management accounting and reporting forms a key part of our business support proposition at GroFin, and if you do not know how to do it, our Investment Managers will be happy to help you to get there.