Finance and accounting are terms often used interchangeably. While both are related to the administration and management of an organization’s assets, each contains major differences in scope and focus. When it comes to evaluating and strategizing the financial health of your company or department, it’s important to have a working knowledge of both disciplines.
To understand the difference between finance and accounting, you need to know what each term means.
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What Is Finance?
Finance refers to the ways in which a person or organization generates and uses capital—in other words, how a given party manages their money. This often encompasses activities such as investing, borrowing, lending, budgeting, and forecasting.
The field of finance can be broken down to hone in on the specific types of parties involved, including personal finance, corporate finance, and public finance. While these categories typically include a similar set of activities, each type of finance has nuances that reflect the different regulations, considerations, and concerns of each population.
Related: 5 Reasons Why You Should Study Finance
What Is Accounting?
Accounting, on the other hand, refers to the process of reporting and communicating financial information about an individual, business, or organization. Rather than making strategic financial decisions, accounting captures an accurate snapshot of a party’s financial position at a specific point in time—a practice that results in the information that finance activities are generally based upon.
The typical activities involved in accounting include recording transactions, collecting financial information, compiling reports, and analyzing and summarizing performance. The results often include thorough financial statements—including income statements, balance sheets, and cash flow statements—that are used to understand an organization’s position at a given time.
Related: How to Prepare a Balance Sheet: 5 Steps for Beginners
Accounting is often broken down into two segments: Managerial accounting and financial accounting.
The main difference between managerial and financial accounting lies in the organization and presentation of information. Managerial accounting focuses on internal accounting processes and generates reports that are referenced by management, while financial accounting focuses on aggregating information into financial statements for both internal and external use.
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To help elevate your business fluency, here’s a look at the differences between finance and accounting.
The Differences Between Finance and Accounting
1. The Scope and Focus
Finance and accounting operate on different levels of the asset management spectrum. Accounting provides a snapshot of an organization’s financial situation using past and present transactional data, while finance is inherently forward-looking; all value comes from the future.
Accounting
In accounting, insight into a firm’s financial situation is gained through the “accounting equation,” which is: Assets = Liabilities + Owners’ 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). And it must balance out—the assets on the left should equal the claims against those assets on the other side. It’s a fundamental means for determining whether a company’s financial records accurately reflect the transactions carried out over a period of time.
Finance
When assessing performance through the lens of finance, cash is king. Unlike accounting’s reliance on transactional data, finance looks at how effectively an organization generates and uses cash through the use of several measurements.
Free cash flows is arguably the most important one, which examines how much money a company has to distribute to investors, or reinvest, after all expenses have been covered. It’s a strong indicator of profitability, and can be used to make present-day investment decisions based on an expectation of future payoff.
Related: Finance for Non-Finance Professionals: 14 Terms You Need to Know
2. Measuring Financial Performance
This difference in scope underscores a contrast between the underlying principles of accounting and finance.
Accounting
The accrual method of accounting, which is followed by most organizations, records transactions as they are agreed upon, as opposed to when they are completed. It allows for transactions to be made with credit or deferred payments, and operates under the idea that revenues and costs will smooth out over time to more accurately depict economic reality. This makes it possible to compare year-on-year growth of a company’s revenues, costs, and profits without factoring in one-off events, as well as seasonal and cyclical changes.
Finance
Finance rejects that idea, instead believing that the best way to measure economic returns from a company is to calculate the cash it’s able to produce and leverage, which is dependent on when that cash is exchanged—rather than just agreed upon.
3. Assessing Value
Another point of difference between the disciplines is their approach to value.
Accounting
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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. Under this doctrine, if you don’t know the value of something precisely, you count it as zero. Doing so helps businesses avoid overextending themselves by underestimating the value of assets and overestimating the liabilities that they owe.
Finance
This is handled much differently in finance, which employs an analytical process, known as valuation, to determine the worth of a company, project, or asset. The gold standard is discounted cash flow analysis, which is applied to a series of cash flows over a period of time. The discount rate (represented as a percentage) accounts for opportunity cost, inflation, and risk, and brings the value of a future stream of cash to its present value.
Related: How Do Companies Keep Track Of Their Monies?
Finance or Accounting: Which Is Better for You?
Both finance and accounting are highly valuable for assessing a company’s position and performance. By understanding the underlying principles of the two disciplines and how they contrast, you can develop greater financial intuition and make better business decisions.
If you’re trying to decide which area you need to brush up on, consider how you can apply these skills.
For those who want to better understand their organization’s financial performance in the context of the markets and contribute to financial strategy, exploring the fundamentals of finance can be beneficial. If you’d like to learn more about the mechanics involved in your organization’s finances and what impacts them, learning the basics of financial accounting, improving your financial literacy, and developing accounting skills can help you reach your goals.
If you’re considering pursuing a finance-related career, taking the time to develop a foundational knowledge of key finance and accounting principles can prepare you for success as you pursue a formal education in your desired discipline.
In either case, developing your financial acumen is key to making better business decisions. From deciding where to invest and how to allocate resources, to understanding the financial health of your organization, or even making the case for a project, many of the business decisions professionals face daily are rooted in finance and accounting.
Do you want to take your career to the next level? Download our free Guide to Finance and Accounting to explore the financial skills all managers need. Or, consider enrolling in our online courses Financial Accounting and Leading with Finance, and discover how you can unlock critical insights into your organization’s performance, potential, and financial goals.
This post was updated on April 19, 2022. It was originally published on June 27, 2019.
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Category: Finance
