Managerial accounting techniques: Tools for effective decision-making
To non-accountants, the work that management accountants do might seem like magic. They can take tons of disparate data and turn it into clear, actionable insights that help businesses improve their bottom line.
To support effective decision-making, management accountants use a range of specialized techniques that help evaluate options and drive strategic growth.
Let’s explore some of the top managerial accounting techniques in use in the Philippines today:
- Variance analysis: Variance analysis is all about comparison. Accountants take your actual performance data and compare it to your budget or standard figures. Then, they look for discrepancies. Say, for example, your budgeted production costs are ₱200,000, but your actual costs were ₱250,000. Something’s not right. This variance might signal a need to investigate supplier pricing or labor efficiency.
- Cost-benefit analysis: Business is all about ideas, but before you jump at the idea of launching a new product or investing in new tech, you’ll need to weigh up its financial viability. Management accountants weigh their expected costs against anticipated benefits. This is cost-benefit analysis.
- Product costing: Similarly, businesses need to know the total cost of a product or service. So, management accountants add up all the costs to produce a figure. Only then can the business hope to settle on a competitive price that ensures a profit.
- Marginal costing: Marginal costing focuses on the cost of producing one additional unit of product. This technique helps businesses make short-term decisions, like whether to accept a special order at a discounted price or increase production volume.
- Cash flow analysis: Even more important than predicted revenue is cash flow. After all, without the right amount of cash freely flowing into your business, you won’t be able to plan investments or grow. Management accountants use advanced methods to figure out exactly how much money is coming and going at any given time.
We’re just scratching the surface here. These managerial accounting techniques, and others, are all complex processes that take years of training to master. Let’s put a few of them under the microscope:
Variance analysis: Monitoring financial performance
You might spend hours budgeting out your expected costs. But that doesn’t mean your costs have to play ball. Sometimes, businesses find that their actual costs don’t match their predicted costs. This difference, or variance, between planned and actual outcomes, is the realm of variance analysis.
Variance analysis, or analysis of variance (ANOVA), is crucial. It helps organizations understand where they’re falling short and make timely corrective decisions.
Of course, variances aren’t all bad. A variance can be either favorable or unfavourable.
And management accountants don’t just analyze variance in one area, either. They typically analyze variances across several key areas, including:
- Sales revenue
- Direct costs (like materials and labor)
- Overhead expenses
- Profit margins
The benefits of variance analysis should already be becoming clear. On the surface, it prevents you from getting any nasty surprises when your bank accounts don’t match your books. But apart from that, it also aids:
- Performance evaluation: Making sure departments are aligned with financial goals.
- Budget refinement: Adjusting your budget to set more realistic goals.
- Strategy adjustment: If a product consistently underperforms against budget, it might prompt a pricing review or marketing push.
Cost-benefit analysis: Evaluating financial viability
New ideas and initiatives are one of the most exciting parts of running a business. Perhaps you’ve got an idea for a new product, or you’re considering opening a new store in another city. Before you greenlight the project, you’re going to need to see if you can afford it. That’s what cost-benefit analysis (CBA) is for.
CBA involves comparing the total expected costs of a decision with the anticipated benefits. That way, businesses can determine whether the investment will deliver a worthwhile return.
There are three basic steps to CBA:
- Identifying costs: Firstly, management accountants go through the plans and total up all the relevant costs. That includes direct costs (like materials, labor, and equipment) and indirect costs (like administrative overhead and potential downtime).
- Quantifying benefits: This is a little trickier to pull off. That’s because, while some benefits are tangible (like increased revenue or cost savings), some are not. For instance, the project might boost your brand value, but it’s tough to put a figure on how much that’s worth.
- Comparing: Management accountants and business leaders determine the net benefit. They then decide whether or not the project is financially viable.
Let’s look at a brief example:
You’re a medium-sized manufacturing company based in Laguna. You’re considering installing solar panels to reduce electricity costs.
Costs:
- Initial installation cost: ₱2,500,000
- Annual maintenance cost: ₱50,000
- Opportunity cost (cash tied up): ₱100,000 (estimated)
- Total cost = ₱2,850,000
Benefits:
- Annual savings on electricity bills: ₱600,000
- Tax incentives and renewable energy subsidies: ₱200,000
- Brand image improvement: Increased customer loyalty and eligibility for eco-conscious B2B partnerships (estimated value: ₱100,000 in additional annual revenue)
- Total benefit = ₱3,500,000
As the net benefit would be ₱650,000, this would be a financially viable project.
Product costing: Determining accurate product costs
Product costing is a fundamental managerial accounting technique. Essentially, management accountants identify all the costs associated with producing a specific product or service. This gives the business a cost-per-product they can then use to make better pricing decisions and control expenses.
However, not all product costing is the same:
- Job order costing: If your products are made-to-order, or made in small batches, you can use job order costing. This tracks costs per product or job. Particularly handy in custom furniture manufacturing or construction, or for small ecommerce stores.
- Process costing: Process costing is better for industries that see continuous production. Think food processing or chemical manufacturing. Here, costs are averaged over all units produced as there are too many to calculate individually.
- Activity-based costing (ABC): Assigning costs based on the activities that drive them, offering a more precise picture of overhead distribution.
Product costing helps businesses price their products at exactly the right levels, not too low to erode profit margins, not too high to become uncompetitive.
In a price-sensitive market like the Philippines, getting your pricing strategy right is crucial. Don’t just sell, sell profitably.
Marginal costing: Assessing impact of production changes
Marginal costing is where variable costs come into play. It is used to analyze the financial impact of producing one additional unit of a product.
You might be wondering why a business would need to know that. Marginal costing helps businesses make important short-term decisions, especially about pricing and resource allocation. It’s also crucial if you’re planning on scaling your operations.
Here’s the key thing, in marginal costing, only variable costs (like raw materials, direct labor, and utility expenses tied to production) are considered when calculating the cost of additional output. Fixed costs, such as rent or salaries, are excluded from individual product unit costs. This approach provides a clear view of the incremental cost of scaling up production.
Here’s an example:
A manufacturer in Cebu sells handmade leather wallets. The variable cost of one wallet is ₱350. A special order for 200 units comes in at ₱400 each. Marginal costing can help determine whether accepting the order is profitable, even if it’s below the regular selling price.
That’s not the only time marginal costing can play a role. The process is also important in:
- Pricing decisions during sales promotions or in competitive markets.
- Break-even analysis to understand the minimum sales needed to cover costs.
- Evaluating production scenarios, such as whether to increase output or discontinue a product line.
When it comes down to it, marginal costing is about making quick strategic decisions. And that’s extremely important, especially in the Philippines’ competitive retail and manufacturing sectors.
Cash flow analysis: Ensuring financial liquidity
As anyone with any experience in management accounting will tell you, profitability isn’t everything. Cash flow is equally, if not more important. After all, without healthy cash flow, a business might not be able to continue producing or selling. In that case, profitability becomes impossible anyway.
So, cash flow analysis ensures a business has enough liquid assets on hand to meet its day-to-day financial obligations.
We can break this down into three main areas:
- Operating activities: Cash from sales and services.
- Investing activities: Cash spent on or received from buying or selling assets.
- Financing activities: Cash from investors and loans, or payments made to settle debts.
These three factors all determine cash flow. And they can make a huge difference to your perceived revenue. For instance, a small logistics company in Davao might show a profit on paper, but if its clients delay payments, it could still struggle to pay drivers or maintain vehicles. That could mean closure.
So, you should invest in cash flow analysis if you want to:
- Avoid liquidity shortages
- Plan for upcoming expenses
- Evaluate investment decisions
- Improve creditworthiness
As any Filipino SME knows, access to finance can be limited. So, making the most of your current funds and keeping cash flow smooth is absolutely fundamental.
