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Small business


A friend has asked you for some advice: �My small business now makes a profit; I am only too aware of
this, as I now face a big tax bill each year, when my tax accountant has prepared my annual accounts.
However, I don’t feel much better off personally, so this is not quite what I had expected when I took the
risk of resigning my job and setting up my own firm. The accountant is now trying to persuade me to pay
her even higher fees, by letting her prepare monthly �management accounts� for me. She says that I
would also benefit from something called CVP analysis on my various product lines. I know that you are
now doing an MSc. What does she mean here, and is this likely to be worth my paying her for?�
In formulating your Key Concept Exercise, consider the following questions:
�What is the difference between financial reporting and management accounting?

�What are the benefits and potential problems associated with cost-volume-profit (CVP) analysis?

�What advice would you give your friend?

The need to maintain comprehensive financial records is fundamental for any organization
whose objective is to create successful business. In this regard, it would be a wise decision to
invest in management financing; which will help to effectively monitor the business’ progress,
forecast future business environment and make effective decisions.
It is important to understand that management accounting differs from financial accounting and
that each plays a different role in the organization. While financial accounts are generally
prepared for the external audience, management accounts are meant for internal stakeholders and
are specifically developed for the management to track specific areas of the business for specific
periods. Management accounting helps managers in making accurate decisions through detailed

reports that address specific financial issues which may be based both on the past and projected
data (Fotache et al, 2010, p. 46-47).
While financial accounting focuses on reporting profitability, managerial accounting is mostly
concerned with identifying underlying problems and how they can be fixed to promote
profitability (McCrary, 2010, p. 24). In essence, financial accounting is only concerned with the
outcome of the company’s system for profit generation while managerial accounting is
concerned with identifying any bottle necks and certain measures to counter them in order to
promote profitability (Jurus, 2014, p. 76). Unlike financial accounting which only calls for the
preparation of accounts for an ended financial period, managerial accounting helps the
management to assess the situation at the organization more frequently and thus make the correct
decisions as deemed necessary (Fotache et al, 2010, p. 47-48). Lastly, unlike financial
accounting which must be compliant with set financial standards, managerial accounting is
meant for internal consumption and therefore does not need to comply with any standards.
Cost-Volume-Profit (CVP) analysis is utilized in determining the impact that changes in costs
and volume of products and services on the operating income of the company. Horngren, Datar
and Rajan (2012, p. 87) note that CVP plays a significant role in decision making by providing
answers to practical questions necessary for business analysis; hence the need for businesses to
invest in CVP.
In order to make the decision on whether to conduct CVP, a business owner must be familiar
with various benefits and problems; which are explained as follows. The first advantage is that
CVP analysis is highly detailed and thus reflects the exact position of the company. Managers
can thus use information including the costs required for producing a certain amount of product
to make accurate budget projections to ensure the desired amount of profits is achieved
(Horngren, Datar and Rajan, 2012, p. 128) . Secondly, profit planning can be achieved through
using CVP to identify the most profitable combination between cost, volume and selling price.
Finally, CVP is useful in price determination through analyzing fixed and variable costs
(McCrary, 2010, p. 96)

A major limitation of CVP is that information obtained is largely estimated. This is despite using
specific data and paying much attention to detail. Horngren, Datar and Rajan (2012, p. 132) note
that it is better at answering hypothetical questions rather than providing actual answers. The
second limitation is that CVP is not as effective when it comes to multiple products. Analysis has
to be performed on each single product and this is usually a challenge for businesses with
multiple products especially where each product has different variable cost ratios.
Based on the above information, I would advise that you allow the accountant to prepare
management accounts as well as undertake CVP analysis. It is better to spend additional cash in
developing financial information that will be useful in assessing the financial position of the
company and making effective decisions; than to make losses or lose the business due to factors
that would have been addressed through actions such as management accounting.


Reference list

Fotache, G, Fotache, M, Bucşă, R, & Ocneanu, L 2011, ‘The Changing Role of Managerial
Accounting in Decision Making Process Research on Managing Costs’, Economy
Transdisciplinarity Cognition, 14, 2, pp. 45-55, Business Source Complete, EBSCOhost,

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