Definition: What is (management) accounting?
Accounting is one of the essential tasks of every company: all financially assessable processes or transactions are recorded, structured and evaluated. This allows you to maintain an overview of your financial resources and the success of your own activities.
On the one hand, this information enables internal managers to plan and make better decisions. On the other hand, the state obliges companies to have a correct accounting system and to provide information to tax authorities or investors. Important accounting tools include bookkeeping, controlling, profit and loss accounts, balance sheets and annual financial statements.
The four tasks of accounting
Documentation
Legislation stipulates that all business transactions in a company must be fully recorded: they are posted to so-called accounts. Associated documents such as invoices and delivery bills are also collected and archived. This is intended to prevent fraud and tax evasion, for example. Documentation is also the basis for all other accounting tasks: a company can only be managed responsibly if you know about its financial situation.
Duty to inform
Companies are also required to publish certain figures. The tax authorities use the annual financial statements to determine the tax burden or other statutory payment obligations. Banks, investors or suppliers want to find out about a company’s situation before they invest or conclude a transaction.
Control
The management makes decisions based on the figures from the accounting system. It can assess which activities bring the best results, which processes should be optimized or which risks are imminent. To this end, management and executives receive regular reports and evaluations from Controlling.
Planning
The management also wants to make strategic decisions for the future. To do this, it not only needs current figures, but also plans or forecasts about the likely development of the company. It sets targets and develops measures to achieve them.
Sub-areas of accounting
Financial accounting (external accounting)
Financial accounting (FiBu) documents all business transactions and creates financial reports from them. These are primarily intended to provide objective information for external recipients:
- Tax office and other state authorities
- Employees
- Suppliers
- Banks, creditors
- Partners, investors, shareholders
- Press and public
Important financial accounting instruments are
- General ledger: The central ledger in which all business transactions are recorded in their accounts. It provides a comprehensive overview of all financial activities.
- Sub-ledgers: Used to record specific business transactions in detail that are summarized in the general ledger. Examples are the accounts receivable and accounts payable ledger, asset ledger, stock ledger, etc.
- Chart of accounts: A systematic list of all accounts used in a company’s accounting, organized according to a specific scheme.
- Journal (diary): A chronological record of all business transactions before they are transferred to the general ledger.
- Balance list: A list showing all account balances at a specific point in time. It is used to check the account balances and prepare the annual financial statements.
- Cash book: Records all cash movements, both deposits and withdrawals.
- Profit and loss account (P&L): Shows the income and expenses of a company over a certain period of time and determines the profit or loss.
- Balance sheet: A comparison of a company’s assets (assets) and liabilities (liabilities) at a specific point in time, which shows the financial situation. It is usually prepared for the annual financial statements.
- Notes: Explains and supplements the figures presented in the annual financial statements and is part of the official annual financial statements.
- Management report: Provides an overview of the company’s economic situation, including developments, risks and outlook. This is particularly relevant for stock corporations.
The German Commercial Code regulates the obligations of companies in the context of financial accounting.
The main purpose of this area is to provide information to external bodies. Nevertheless, the documented figures are also used for other internal purposes.
Controlling (internal accounting)
Controlling supports company management in monitoring and controlling all company processes. It provides data as a basis for internal decisions. In particular, it monitors whether plans have been adhered to and targets achieved. The aim is to ensure the profitability and efficiency of the company.
The information is intended for management, executives and cost center managers.
Important controlling instruments are
- Cost accounting systems: Used to record, allocate and analyze costs. These include full cost, partial cost, process cost, cost element, cost center, cost object and cost object unit accounting.
- Key figure systems: The performance of the company is monitored and evaluated by determining individual, meaningful key figures, for example ROI (return on investment) and cash flow (liquidity)
- Risk management: Identification, analysis, evaluation and control of risks in order to ensure the achievement of corporate goals.
- Reporting: Systematic preparation of analyses and reports on the company’s financial and operational performance for internal persons.
Business statistics and comparative accounting
In this area, statistical methods and various types of analyses and comparisons are used to gain new insights. Both internal business data and external data are collected and evaluated for this purpose. The recipients of the analyses are potentially all internal departments; these are to be supported in controlling, planning and other decisions.
Important instruments or methods in this area are
- Descriptive statistics: Includes the description, preparation and presentation of data sets. This includes measures such as mean, median, mode, dispersion and the creation of frequency distributions.
- Inferential statistics: Enables conclusions to be drawn about the population on the basis of samples. Methods such as confidence intervals and hypothesis tests are common here.
- Time series analysis: Examines data collected over a period of time to identify trends, seasonal fluctuations and cyclical patterns.
- Index figures: Are used to show the relative change in economic variables over time or in comparison to a base period. Examples are price, quantity and value indices.
- Correlation and regression analysis: Determine the relationship between two or more variables. While correlation analysis measures the strength and direction of a relationship, regression analysis attempts to model the nature of the relationship and make predictions.
- Benchmarking: A systematic comparison of processes, products or services with those of the strongest competitors or companies that are considered the best in the industry in order to identify performance gaps and derive improvement measures.
- ABC analysis: A method of classifying objects (e.g. customers, products) based on their importance, with A being the most important category and C the least important. Often used to prioritize management measures.
Planning calculation
Planning includes the preparation of financial plans, budgets and forecasts in order to manage future business activities. Among other things, the plans are used to decide how much money will be spent on what, how much staff or other resources are required and what measures a company wants to implement. This information is primarily required by the management, the finance department and the cost center managers.
Important instruments in the area of planning are
- Budgeting: The preparation of budgets for specific periods (usually one year) for various areas or projects within the company. Budgets serve as financial guidelines and targets.
- Financial planning: Long-term planning of cash flows to determine liquidity, capital requirements and sources of financing. Financial planning includes capital requirements planning, source of funds planning and liquidity planning.
- Cash flow statement: Forecasts the cash flows that flow in and out of the company in order to monitor and secure liquidity. It is a key tool for short to medium-term financial planning.
- Investment appraisal: Evaluates the profitability of investments using methods such as the net present value method, internal rate of return method, amortization calculation and the annuity method. These analyses support decisions on capital investments.
- Break-even analysis: Determines the point at which the total costs and total revenue of a product or project are equal, i.e. no profit or loss is made. This helps to assess financial feasibility.
- Scenario analysis: Develops various “what-if” scenarios (best case, worst case, realistic) to evaluate potential futures and their impact on the company.
- Risk management: Identifies and evaluates risks that could impair the achievement of financial targets and develops strategies to minimize risks.
- Rolling forecast: A dynamic planning method in which plans are regularly updated to reflect changes in the business environment or business objectives.
Important accounting terms
Double-entry bookkeeping (debit and credit)
Double-entry bookkeeping is a fundamental principle in accounting. Two entries are made for each business transaction: one in debit and one in credit. This method ensures the accuracy of financial data and guarantees that a company’s balance sheet is always balanced.
For example, a company buys office supplies worth EUR 100 on account. In this case, the office supplies are posted as an expense in the debit side of the expense account because they increase the value of the company’s resources. At the same time, an entry is made to the credit side of the liability account, which represents the company’s debt to the supplier. As a result, both the assets (due to the possession of the office supplies) and the liabilities (the debt to the supplier) increase by EUR 100.
Income and expenses
Revenue comprises all funds that flow into the company, for example through the sale of goods or services, interest income or income from rentals.
Expenditure, on the other hand, refers to the money spent on goods, services, salaries or other operational requirements.
Costs and services
Costs arise from the consumption of resources or services for the creation of products or the provision of services. They include material costs, personnel costs and other expenses.
Services, on the other hand, refer to the value of the goods and services produced by a company. This can refer to the sales revenue, but also to services provided internally that are not sold directly.
Income and expenses
Income refers to all value inflows into a company within an accounting period. It arises from the sale of products or services, rental income or interest income.
Expenses, on the other hand, include all outflows of value that were necessary to generate income, such as material costs, wages, depreciation and rental costs.
Income and expenses are included in a company’s income statement.
Profit and loss
Profit arises when the income from the sale of products or services is higher than the expenses incurred, including all expenses. A loss, on the other hand, occurs when expenses exceed income.
Liquidity and cash flow
Liquidity refers to a company’s ability to meet its short-term financial obligations: Paying suppliers, paying salaries and covering other ongoing expenses. It is a measure of how quickly assets can be converted into cash to meet such obligations.
Cash flow is a key concept for assessing liquidity. It shows the actual movement of money in a company – i.e. the difference between incoming and outgoing cash flows within a certain period of time. There are three main types of cash flow:
- Operating cash flow: Cash flow resulting from normal business activities, such as the sale of goods and services.
- Investment cash flow: Includes cash flows from the purchase or sale of fixed assets such as machinery or buildings.
- Financing cash flow: Cash flows associated with the raising and repayment of capital, including dividend payments and borrowings.
A positive cash flow shows that a company is earning more money than it is spending, which is a sign of financial health.
Assets and liabilities
Assets represent the assets of a company, i.e. everything that the company owns or is entitled to. They include tangible assets such as buildings, machinery and inventories as well as intangible assets such as patents and trademark rights. Assets are further divided into current assets, which can be converted into cash within one year (such as inventories or receivables), and non-current assets, which are used over the longer term (such as land and buildings).
Liabilities show what obligations the company has, i.e. everything it owes to others. These include current liabilities, such as supplier credits, which must be settled within one year, and non-current liabilities, such as loans, which are repaid over a longer period of time. Equity is also listed under liabilities and represents the value due to the owners of the company after all liabilities have been deducted.
The balance sheet of a corporation consists of assets and liabilities; both areas must be balanced. This principle reflects the fact that all of a company’s resources (assets) must be financed by debt (debt-financed liabilities) and the property of the shareholders or owners (equity).
Accounts receivable and accounts payable
Debtors are customers to whom a company has sold goods or services on credit and who still have outstanding payments to make. In the balance sheet, debtors are carried as part of current assets, as they are expected to generate cash within a financial year when customers pay their invoices. Debtors therefore represent receivables: Money due to the company.
Creditors are suppliers or service providers to whom a company owes money because it has received goods or services on account. Creditors are listed under current liabilities in the balance sheet, as they usually have to be settled within one year. They represent a company’s financial obligations to its suppliers.
What is the difference between accounting, bookkeeping and controlling?
Bookkeeping (or accounting) and controlling are part of accounting.
Accounting refers to the entire system of recording, processing and analyzing a company’s financial information.
Accounting deals specifically with the systematic recording of all financial transactions of a company. It prepares the annual financial statements and ensures compliance with legal regulations.
Controlling supports management in steering the company by monitoring operational processes and planning. It is future-oriented and focuses on optimizing company performance.
Interesting facts from the blog
- How to use your ERP data to make better decisions
- The most important functions of an ERP system for finance and accounting
