Capital market deals with long-term funds where risks are constant companions of general and institutional investors. To guard against risks we take many active and passive measures through diversification and external & internal hedging techniques. Managing risks is the responsibility which ultimately rests on the investors. Even when precautionary measures are undertaken, some risks, which are commonly known as residual risks, can't be avoided.
In our capital markets, institutions invest directly through their own dealers and they manage investments of their clients also. Despite knowing investment research & analysis well, a capital market firm, i.e., merchant banks, asset management companies, brokerages, etc, can go bust because of not realising their own position and capacity to take certain level of risks. If the institutions don't know or bother about their company's strengths and risk appetite, they can't invest in high risk profiled securities or they can't lend to their clients to buy such securities. In addition, weak governance may lead to winding up for many companies in the long run.
Here comes the role of management accounting. It is the process of identifying, measuring, analysing, interpreting and communicating information for the pursuit of an organisation's goals.
The key difference between management and financial accounting is: management accounting information is aimed at helping managers within the organisation making decisions, while financial accounting is aimed at providing information to parties outside the organisation. In management accounting, managers use the provisions of accounting information in order to better inform themselves before they decide matters within their organisations, which aids their management and performance of control functions.
Management accounting for use inside an organisation must reflect the reality of the operations and resources used by the organisation in monetary terms. Unlike financial reporting, where the focus is on external investors and creditors seek to compare investment options across the capital markets, management accounting focuses on the economic choices and constraints within an organisation.
There are two parts, which are interrelated, in understanding why management accounting principles are so important and how these principles help managers achieve their primary objective: enterprise optimisation.
The first part deals with the actual modelling of a company's operations, where the management accountant establishes and builds causal relationships based on the principle of causality and related management accounting concepts. Part two involves the principle of analogy and the manager's analytical needs for decision support information provided by part one (its cause-and-effect relationships). Part two requires analysing the information in light of one or more decision alternatives so that the decision maker(s) can reach the optimum decision. The cumulative application of both principles (causality and analogy) achieves management accounting's objectives and fulfills the managers' needs - the optimisation of the company's operations, generally referred to as enterprise optimisation.
Like manufacturing companies, financial institutions also need management accountants to have better understanding about different functions of business, to manage risks, to formulate strategies and to ensure better performance. In our capital markets there are many areas or functions where management accountants can contribute. The areas can be corporate governance & internal control, management reporting & strategy formulation, budgeting & forecasting, investment appraisal, financial management, etc. Management accountants can play a key role in keeping a safeguard against risks by providing relevant information to the stakeholders to make broad decisions, by reducing non-value added activities, by formulating risk-based strategies, etc.
Understanding own business, ensuring good governance, securing cash flows are the preconditions of investing in the markets. Without taking these measures investments can be jeopardised to a great extent.
Before 2007 United States created many financial products like CDO, credit default swaps, etc., to hedge the risks of the US subprime mortgage market. But many firms went bust due to weak governance, fraudulent activities and weak financial control despite availing the derivatives instruments.
In Bangladesh, few companies have portfolio & research departments which play a vital role in the area of investment research & investment management. But there is hardly any instance of management accounting activities. In most of the cases, finance departments absorb some responsibilities of management accountants which are inadequate and less relevant in some cases due to lack of specialisation. If there had been clear functionalities of management accountants, the companies could have better understanding about their risk capacity. In that event, stock picks, lending to clients, etc. would have been more efficient.
In many developed countries like US, UK, Germany, and France, management accountants are playing key roles in the financial markets. Some global investment banking giants, i.e., Goldman Sachs, JP Morgan, BNP Paribus, etc., employ management accountants in the area of investment analysis, performance management, risk management, etc.
Here in Bangladesh also, we need management accountants for our capital markets to tame risks, to secure cash flows, to ensure solvency, to manage assets and to maximise shareholders' wealth.
The writer is Senior Research Analyst at Royal Capital Ltd.
