Management accounting is internally focused and provides the decision makers with the financial data necessary to make sound managerial decisions. These techniques include budgeting, variance analysis, cost accounting and ratio analysis. Decision making becomes more of a scientific process than a gamble. The accounting information is used to compile reports for the management team and reduces the inherent financial risk of operating a business.
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The budget process begins before the financial year starts. It establishes the operating budgets for the following year's operations. The goal is to predict the likelihood of certain business outcomes in an effort to create a realistic estimate of the future expenses and needs. This is done by creating pro-forma analysis models and statements. This process looks at the historical sales and expense as well as the historical increases and decreases in those costs and expenses. These figures are used to generate a hypothetical business year or pro-forma statement. These budgets are generally considered flexible because of the extreme fluctuation in price and availability of commodities.
Variance analysis is the technique used to compare budgeted financial performance and expenses to the actual performance and expenses. The variance is the difference between the budgeted and actual results. The analysis can be performed on revenue, expenses, overhead and other financial data. There are three classifications; positive variance, negative variance and null variance. Positive variances are favourable to the company because less money has been spent to achieve a specific goal than was budgeted. A negative variance means that more money has been spent than was budgeted. A null variance is also positive to a company because that means that they were exactly on budget. A null variance generally only happens in the academic world however. This process is a steering mechanism that allows the company to redirect the process toward a positive variance.
Cost management uses cost accounting techniques to examine the cost of operations and breaks those costs down into quantified units that can be assigned to individual processes or products. An example would be to break the cost of raw material down to the per-unit level. This allows a company to determine the cost of raw materials that goes into each widget that it manufactures. This helps keep costs within acceptable ranges. Cost accounting focuses on multiple input sources, such as man hours, machine hours, raw material consumption. These techniques are used to determine the true unit cost of a process or product. Once the unit cost has been determined, it can be analysed for cost reductions, cost cuts and process changes.
Ratio analysis is used to evaluate a business' results beyond the data supplied by the financial statements. Financial statements are used to perform ratio analysis. This technique provides data that is hidden within the financial statement itself. These ratios can provide information on a company's liquidity, solvency and profitability levels. Liquidity is the ability to pay its short-term debts, while solvency demonstrates its ability to pay its long-term debts. These ratios can tell a financial institution or executive team how strong the company is financially. This will demonstrate if a company has a "Going Concern" issue. The Going Concern Policy determines whether a company will be viable to remain in operation into future business periods.
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