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Management accounting is a field that has gotten itself more than one name. This is because the definition of this branch of accounting is somewhat fundamental yet elusive, and the ways to describe it are numerous.
Nevertheless, the primary purpose of management accounting is to identify, measure, analyse and interpret accounting information so that it can be used to influence behaviour at all levels, from the Chief Executive Officer (CEO) down to each individual employee, to help them make informed operational decisions.
A secondary purpose is to stimulate investigation and discovery by signaling relevant information, consequently bringing focus and generating questions. This may sound easy, but in reality, management accountants rely on a variety of different techniques in order to achieve these purposes.
The marginal cost of production is an important concept in management accounting, as it can help organisations optimise their production through economies of scale – the reduction of production costs as a result of making and selling goods in large quantities.
Management accountants use the technique of marginal costing to identify differential costing and break even analysis for direct cost control, decision-making and profit maximisation. In the absence of this information, an organisation will not know when to expand production or determine at which point it can achieve economies of scale.
Capital budgeting is concerned with the analysis of an organisation’s inflows and outflows to determine whether the expected return meets a set benchmark. It is usually used by organisations to evaluate major projects and investments, such as new plants or equipment.
In this analysis, management accountants calculate metrics like the net present value (NPV) and the internal rate of return (IRR) to help managers decide on the best investment alternative to maximise the benefits for the entity.
This very important technique brings to light the value of unsold inventory or unused materials at the time of preparing financial statements. Inventories can potentially be the largest current asset of an entity and an analysis will help to determine the organisation’s inventory turnover ratio, influence purchasing decisions, evaluate the cost of goods sold (COGS) and profitability.
Often, management accountants use techniques such as FIFO (first-in, first-out), and AvCo (weighted average cost) for such valuation. Inventory valuation is subject to critical review by external auditors as well.
Product costing is the accounting process of determining the costs incurred to create a product. These costs can include consumable production supplies, worker wages, compensation, production transportation costs, retail stocking fees etc. A manager uses these overall costs to plan a variety of business strategies, including setting product prices and developing promotional campaigns.
Trend analysis involves the collection of product costs and/ or revenue from multiple time periods and analysing the information. The intent of this analysis is to spot actionable patterns and analyse the amount change and percent change from one period to the next.
This management accounting technique is used to identify areas within an organisation that are doing well and areas that are not doing well. In this way, it provides valuable evidence to help make better decision making around longer-term strategy and ways to future-proof a business.
Many organisations are worried about bottlenecks that could potentially hold back the full potential of a business. That is why management accountants will use this technique to primarily identify inefficiencies created by these bottlenecks, and their impact on the company’s ability to generate revenue and profit.
The manager will then put this information to work to improve the capacity at the bottleneck and deal with such constraints effectively.
In summary, focusing on these 6 management accounting techniques will put management accountants in the forefront of all financial activities, enable them to formulate financial policies and develop the financial procedures at optimum level.