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Areas of Accounting and Their Relationship to your Business

Financial Accounting, Managerial Accounting, and Cost Accounting

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Accounting and finance are integrally related in a business firm. Accounting is the study of how information is gathered and distributed in and out of a business firm. Finance, broadly, is the study of how firms make the investment and financing decisions they have to make in order to operate their business. Finance needs accounting information in order to operate. Accounting must have financial experts in order to translate accounting information for general use.

There are three major areas of finance that business owners and managers usually have to be knowledgeable of. There are three major areas of accounting as well:

  1. Financial Accounting

  2. Financial accounting is the area of accounting concerned with external parties interested in the business firm. Financial statements, for example, are produced for the benefit of the external investors in the business firm. Investors need to be able to review financial statements such as the income statement, the balance sheet, and the statement of cash flows in order to determine whether or not invest in the business firm or remain invested in the company.

    Financial statements are also of interest to another group of external individuals and those are the creditors of the firm. Those creditors are the bondholders of the firm or they could be just the debtholders of the firm. Creditors are individuals who have loaned money to the firm and are interested in receiving a return on their investment and, eventually, a return of their principal.

    Financial accounting, according to the Financial Accounting Standards Board (FASB), provides an important financial collecting and reporting functions for business firms.

  3. Managerial Accounting

  4. Managerial accounting is the area of accounting associated with gathering and preparing financial information for those inside business organizations such as managers and staff. It can be compared to financial accounting which is concerned with information for external individuals. Managerial accounting is the field where the gathering and preparation of financial information is for the insiders of the firm. The Institute of Certified Management Accountants states that management accountants are the "value creators" among accountants, thereby taking their place between the finance people and the financial accountants in the business organization.

    Managers use financial information to make better business decisions in their managerial and control roles. Much of this information is private since it is for insiders of the firm instead of public. Also, the information that managerial accounting deals with is "forward-looking" as opposed to historical information like financial accounting uses. They use a variety of forecasting techniques such as variance analysis, risk management, and cost-volume-profit analysis to predict the best forward looking information as possible.

  5. Cost Accounting

  6. Some business professionals include cost accounting as a part of managerial accounting and some think that cost accounting is a different functional area of accounting. Whatever the case, cost accounting and managerial accounting surely overlap.

    Cost accounting looks at the costs of production for a business firm by looking at the fixed costs of the products they sell and their input costs. Input costs are compared to output costs to measure the financial performance of the firm with regard to production costs. Cost elements often used are indirect costs or overhead, raw materials, and labor. Managers often use the information from cost accounting to set up cost control programs for the business firm.

Summary

There are other areas of accounting involved in business firms. There is tax accounting. Business firms may have internal tax accountants or may outsource their tax accounting. The area of auditing is usually both internal and external and budgeting analysis is an internal function. In addition, there is governmental accounting, outside the sphere of business, and forensic accounting, which uses accounting and finance information to support litigation involving fraud and embezzlement.

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