Standard Accounting versus Cost Accounting

Posted by: Seva Procurement on Apr 24, 2014 at 5:37 pm |

There is a critical difference between financial accounting and financial management/cost accounting, though this distinction is not always fully realized by some restaurant operators and managers. While financial accounting generally involves the preparation of strictly financial reports and statements, often for external use, financial management and cost accounting is the process of creating and analyzing these statements, as well as non-financial data and reports, for the purpose of making decisions and constructing systems that improve organizational profitability and efficiency. This difference is illustrated by the disparity between the standard accounting income statement outlining aggregate performance, which provides very limited operationally-ready data, and an operational profit and loss statement that lays out both targeted financial and non-financial data so that key issues can be identified and opportunities realized. A more simplistic example would be that financial accounting reports would be used for tax purposes, whereas financial management reports would be given to operations to assist with decision making. As both the purpose and end-user is different, it should follow that the format, content and level of detail should also differ in these reports. Most corporate operations have a good grasp of financial management and have systems in place to maximize the organizational benefits of this function. Despite the high degree of precision and attention given to financial management among chain operations, independent operators often struggle to operate as effectively with respect to the use of financial management reports.

The first common issue among some independent operators and regional chains is the inability to generate timely reports. As the purpose of these reports is to provide information that identifies current operational trends and opportunities to assist in decision making, it is important that these reports represent recent activity so that decisions are based upon an accurate depiction of the current situation. If reports are not generated in a timely manner, the identifiable issues may no longer apply or may have grown to the point of causing critical damage to an organization. Neither situation is desirable. In the first scenario, management will have missed an opportunity to address an operational deficiency that could be due to poor performance, theft, improper purchasing or receiving, etc. Whatever the reason, it will probably reappear at some point, as it was not identified and corrected. In the second scenario, management will have missed the opportunity to head off an operational issue that has become costly to the organization. Therefore, to react to emerging trends and opportunities identified by financial management reports, it is critical that they are processed, distributed and analyzed quickly. Another way of looking at the need for timeliness with respect to financial management reports is if you look at the use of these reports as a method of behavioral modification. When issues and opportunities (or positive results) are identified through these reports, it is important that the necessary behavioral modification that is needed to address the identified issues occurs relatively soon after the behavioral issue. Behavioral science teaches us that coaching somebody on a mistake that is in the distant past does not have a strong effect on modifying behaviors. While there are many reasons why an organization might consistently produce untimely reports, one common reason for this is an overly acute concern for report accuracy. While financial management reports need to be accurate, they can be less accurate than financial accounting reports. The reason for this is tied to the report’s objectives. While perfect accuracy is both necessary and critical for accounting statements, perfect accuracy is not as critical for the identification of trends and opportunity areas, which is the objective of the financial management report. If this is understood, many operations may find it easier to generate timely reports so that operational decisions can be made, even if the more accurate financial accounting reports have not yet been processed. Often times, communicating this fact to those responsible for report generation will cause them to alter their priorities and improve their efficiency. This simple step can give operators a powerful tool for improving profitability.

Another common issue is an operator with little accounting experience and who is, therefore, uneasy about directing the accounting “pro” as to how and what reports need to be generated and in what time frame. As has been previously mentioned, the goal of financial management reports is to improve operational efficiency and profitability. The determination, therefore, of what financial management reports need to be generated should be determined by the operator. Just like financial accounting reports are created and formatted according to the instructions of the end user, such as the IRS, financial management reports, likewise, need to be generated based on the direction given by their end user, the operator. If an organization is large enough to have an accounting department headed up by a CFO or controller with a strong hospitality background, this is not necessarily a huge problem, as this individual should be able to guide accounting towards the production of reports that will be operationally actionable. If, however, an organization does not have the luxury of a large, seasoned accounting department or executive, it becomes the responsibility of the operator/owner to instruct the “accounting” employee as to what management reports are necessary. It is also worth noting that an accounting professional with a long history in the accounting field may not know what information to provide on management reports if their accounting background does not include hospitality experience. Under these circumstances, the operator must again “coach” the professional on what kind or information and report styles are important for running the operation. Whatever the situation for a given operator, it is critical that they question the reports that they are being given to ensure that they provide adequate information for making operational decisions. Remember, just because current reporting contains accurate information and meets generally accepted accounting principles, that does not mean that your financial information is being collected and reported in a manner that best enables management to make operational decisions.

While the exact content, format and detail of management reports should be determined by the specific nature and necessity of an operation, there are certain characteristics that are often incorporated into financial management reports. First, detail is critical. Specifically, data should be broken down into identifiable categories. Consolidating data into actionable categories facilitates the identification of operational and cost trends. The level of category detail should be determined by the level necessary for the data to be “actionable.” While being overly detailed can confuse and hide the existence of trends, being overly general can make information difficult to translate into actionable decisions. For example, expressing alcohol expense and cost on the P&L under the general “alcohol” umbrella can make it difficult to determine whether the issues are with beer, wine or liquor. Therefore, expressing data in specific categories, in this example beer, wine and liquor, will be extremely helpful in identifying trends. Second, in addition to detail, reports should include comparative data. While the type of comparative data varies, the common forms are prior period, same period during prior year and budget. These forms are most common in profit and loss statements, the backbone of the financial management reports. Using such information puts data and information into an understandable context. By comparing current statements to prior historical performance, as well as the budget, operators are able to better identify trends. The manner in which data is expressed is also critical to understanding information presented in reports, such as expressing data in dollars, as a percentage of sales and as a cost per cover. Again, these expressions are critical in evaluating a P&L statement. The P&L is only one of many financial management reports that an operation should have in use. Operations should also be using sales summary reports that calculate daily and weekly sales, labor and guest statistic information, as well as cash flow reports, cost of goods management summary reports, inventory level reports, etc. The exact reports used by an operation and the level of detail necessary will vary by operation, but what will not vary is the effectiveness that the proper use of financial management reports can have on improving operational efficiency and profitability.