What is the difference between financial and managerial accounting?

Why isn't managerial accounting used for external financial reporting? Why isn't financial accounting sufficient to run a company? Find answers to these and other questions in this article.

1. Description of financial accounting

Financial accounting provides information that is designed to satisfy the needs of external users of accounting information.

External users of accounting information include third parties outside the business: existing and potential shareholders, investors, creditors, government authorities, financial analysts, stock exchanges, financial press, labor unions, trade associations, vendors, customers, general public, etc.

Financial accounting is used to prepare financial statements: these statements show the financial position of the business at particular dates as well as the results of operations for a specific period of time. In other words, financial statements help external users of accounting information to make investment and economic decisions and can be used to evaluate the performance of management in running the business. Financial statements normally include the balance sheet, income statement, statement of changes in equity, statement of cash flows, and notes to financial statements.

To record and summarize business transactions and to prepare financial statements, financial accounting uses the double-entry system and follows generally accepted accounting principles (GAAP).

Financial accounting uses historical (i.e., past) data. Business transactions and economic events are measured in monetary units (e.g., US Dollar, Euro, Rupee, Russian Ruble).

Financial accounting is important in running a business as well as in making decisions regarding finance, sales, production, etc. It provides the overall view of a business. However, financial accounting has some limitations. For example:

  • Financial accounting does not provide detailed information about costs (e.g., for different divisions, departments, processes, products, jobs).
  • Financial accounting does not provide enough information about product or service pricing.
  • Financial accounting does not provide enough information to make decisions regarding business expansions, discontinuing operations, new methods of productions, product improvements, etc.
  • Financial accounting is not sufficient to measure the performance of employees and departments.

In other words, financial accounting does not provide enough information to make certain managerial and cost decisions in running a business.

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