Clarifying the difference between accounting and finance

In this article, I am clarifying the difference between accounting and finance to help business owners and entrepreneurs better navigate the development of these key functions in their emerging businesses. Accounting and Finance are important for a business’s success, but they have subtle differences that can sometimes confuse entrepreneurs. Understanding their similarities and differences will help business owners know when they need both services and whether they are relevant to their business. Let’s dive into the topic.

Accounting: Categorization of Financial Events

Accounting is the maintenance and reporting of a company’s financial records through the correct categorization of financial events in the business. It involves recording, classifying, and reporting financial transactions and ensuring that financial records are accurate and compliant with the standard of accounting you seek – generally, this means cash accounting or accrual accounting. Businesses are, by law, required to keep accounts and records of financial statements for taxation purposes, and cash accounting is suitable and the easiest way to go about this. Once you have investors involved in your business, it might make sense to switch to accrual accounting.

Accounting focuses on capturing a company’s financial information at a particular point in time. Usually monthly, quarterly, or annually. Sometimes, weekly accounting is needed to manage tight cash flow, but I don’t view this as accounting, it’s cash flow management that depends heavily on the occurrence of revenues and expenses on a weekly basis which you will find in the accounting records.

A basic principle of accounting is that Assets = Liability + Owner’s Equity. This formula looks at what a company owns (its assets), what it owes (its liabilities), and the residual that belongs to shareholders (owner’s equity).

What is Finance?

Finance is managing the future development of your business financially. Finance involves analysing financial data for strategic investment decisions, budgeting, and risk management. Finance is the strategic management and planning of money over time, focused on optimizing future financial outcomes through investment, funding, and resource allocation decisions. Financial decisions usually cover Capital Structure, Investment Criteria, Risk Management, and Value Creation.

A basic principle of finance is that Risk and Return are related. This principle states that higher potential returns require taking on more risk, and investors must be compensated for taking additional risk. To summarize, finance involves analyzing financial opportunities and risks to make decisions that maximize value creation, which drives the value of your business and makes it have value to a buyer in the future.

While accounting looks backward to record what happened, finance looks forward to planning what should happen. Businesses need finance to grow and make strategic choices about using their resources – generally this means deciding between investing in growth, paying down debt, or returning capital to owners. Basic financial decisions revolve around three key areas: investment (where to deploy capital), financing (how to fund operations), and dividends (what to return to shareholders).

Finance focuses on making decisions about a company’s financial future based on both current data and projections. Usually these decisions cover short-term (operational), medium-term (tactical) and long-term (strategic) horizons. Sometimes short-term financial decisions are confused with accounting, but I view this as treasury management which depends on understanding both accounting records and future cash flows.

Similarities Between Accounting and Finance

The key similarity between accounting and finance is that both have to do with MONEY. They involve recording, analyzing, reporting, and projecting a business’s cash flow. Both accounting and finance, keep track of the assets and liabilities of a company, and are aimed at increasing the profitability and valuation of a business.

Accounting and Finance require similar technical and non-technical skill sets, as well as a keen attention to detail. In terms of career path, accountants and financial analysts can work in similar roles, such as commercial and investment banks, real estate finance, mortgage banks, insurance, or directly serve businesses.

Both can serve individuals, businesses, and the government. But, you should not confuse the capabilities of an accountant to handle finance work and vice versa. However, in my experience, I have found it more likely that a strong finance professional can handle accounting issues than the other way around. Not in every case, but most of the time I have found this to be true as finance inherently involves accounting but you can do lots of accounting without ever having to handle any strategic finance questions or problems.

Differences between Accounting and Finance

The main difference between accounting and finance is that accounting focuses on the past, while finance focuses on the future. Accounting professionals are more focused on professional principles and processes, while finance involves creativity and innovation to think out ways a company can grow profitably.

Accounting focuses on the day-to-day flow of money in and out of a company, while finance is a broader term for managing assets and liabilities.

Accounting focuses on the day-to-day management of financial reports and records in the business world, while finance uses the same information to analyze transactions and project future growth.

When assessing performance through the lens of finance, cash is king. Unlike accounting, which relies on transactional data, finance examines how effectively an organization generates and uses cash through several measurements. They examine how much money a company has to distribute to investors or reinvest after covering all expenses.

Which is more important?

Can you drive a car without a windshield or rearview mirror? Just as we would need vision of what’s in front of us as well as what’s behind us while driving, accounting and finance are equally helpful for a business. Financial decisions are based on accounting information and accounting using feedback from finance to monitor cash flow.

In accounting, a conservatism principle is often applied, which suggests that companies should record lower projected values of their assets and higher estimates of their liabilities. In contrast, finance employs an analytical process known as valuation to determine the worth of a company, project, or asset. This is the basis for the valuation of start-ups and Venture Capital funding.

Regards,