Finance and accounting play crucial roles in the success of any business. These two are essential for any business owner, from small to enterprise.
Differentiating between these two areas’ key functions and detailed responsibilities can be challenging for common business owners. This misunderstanding may result in inconsistencies and missed chances for improving its abilities.
Accounting is the process of documenting, compiling, and reporting a business’s financial transactions. However, the scope of finance is wider. It focuses on managing the capital structure, managing liabilities and assets, and planning for future expansion through careful budgetary strategy and evaluation.
So, in this blog, we’ll discuss the key differences between accounting and finance, and how knowing them can help you in global firms. As the best finance management platform, we are committed to helping our clients understand the difference between finance and accounting.
Let’s get started!
What is Accounting & Finance?
Accounting
Accounting is fundamentally the systematic process of documenting, classifying, evaluating, and summing financial activities. This methodical approach guarantees that each penny made or invested is tracked. Accounting concepts like accrual and consistency help accountants produce financial reports that provide an insightful overview of the economic activity of the organization.
Why Is It Important?
Robust accounting procedures offer both new businesses and established organizations the following crucial benefits:
- Clarity and Adherence
Accounting lowers the possibility of financial mistakes that could result in fines or harm to one’s reputation by assisting in ensuring adherence to rules and regulations.
- Decision-making
Accountants’ financial reports help executives make well-informed judgments about everything from resource allocation to strategic planning, pointing them in the direction of financially sound plans.
- Performance Evaluation
By maintaining a close eye on financial accounts, businesses can assess their progress toward objectives, effectively control their spending plans, and make required corrections.
Finance
Finance, on the other hand, is about the management of assets. The assets include cash, inventory, capital assets, and equipment. It also comprised receivables and liabilities, capital, payables, and loans. This encompasses investing, borrowing, lending, planning, opex budgeting, capital budgeting, and forecasting.
The typical accounting function includes summarizing and publishing financial statements, income statements or profit and loss statements, balance sheets, and cash flow statements. Financial analysts study and analyze this to provide insights to facilitate management decision-making.
In short, it is done with the support of finance activities. These activities follow forecasting the benefits from investments, enhancing the organization’s and its shareholders’ value. Additionally, it covers mitigating and managing risks. Thus, finance plays a considerable role in multinational corporations.
Simply put, accounting refers to the system of recording and maintaining monetary or financial transactions, and finance is about analyzing, planning, controlling, and managing the assets and liabilities of an organization for its future growth. Accounting is about today, and finance is about tomorrow. Accounting can also be broken down into managerial accounting and financial accounting, and this discussion is restricted to financial accounting.
Key Differences Between Accounting and Finance
Comparing budgeting practices in finance and accounting is critical for any financial management.
1. Corporate Compliance
Accounting
International Financial Reporting Standards, or IFRS, are widely used in more than 140 countries, covering the Middle East and Europe. Their goal is to uphold effectiveness, reliability, and openness in the global economy. Companies that use IFRS have to make sure that their reporting is understandable and consistent across borders.
On the other hand, Generally Accepted Accounting Principles, or US GAAP, are an extensive framework of accounting standards that businesses must adhere to in order to prepare financial reports. They are widely used in the US.
Finance
Finance has no such statutory obligations. Except it may be complying with the rules related to foreign exchange, external borrowings, and cross-border investment stipulated by the Central Banks like the Reserve Bank of India (RBI) in India, the Federal Reserve System in the US, or The Saudi Arabian Monetary Authority (SAMA) in Saudi Arabia.
This also includes the Central Bank of UAE, or Reserve Bank of India (RBI) in India, or regulations related to IPO. Further, it follows exchange listing or investments of securities boards like the Securities and Exchange Commission (SEC) in the US or the Securities and Exchange Board of India (SEBI) in India.
2. Focus and Scope
Accounting
While accounting deals with past transactions and financial reporting, finance looks forward to the values that come from the future. In accounting, financial statements are prepared following the equation:
Assets = Liabilities + Shareholders\ fund or equity.
The finance reviews it differently. What a business owns (its assets) in the form of fixed assets and current assets, what it owes (its liabilities) by way of long-term liabilities (loans and liabilities payable after one year) and current liabilities.
Further, the residual (shareholders fund or equity) constitutes the total paid-up capital, current year profit minus appropriations, reserves, surplus, and retained earnings.
Finance
Finance looks at business from a cash perspective and how best its resources can be used to generate cash. Free cash flow is one of the most critical measurements of financial position. This tells the management how much money is available with the company for distribution to the investors and shareholders and reinvesting.
Managing cash flow indicates how strong the health and liquidity of a company are. It also highlights why investment decisions are based on the expectation of future cash inflows.
3. Financial Measurement
Accounting
Most accounting standards, tax authorities, and corporate laws mandate the maintenance of accounting records on an accrual method. Easy transaction management of finances is recorded when the revenues are earned, and expenses are incurred as opposed to when they are received or paid in cash.
Accounting allows a year-on-year comparison of a company’s financial results. This is based on the matching principle that expenses incurred to earn an income should be accounted for in the same period.
Finance
Instead, finance considers the cash a business can generate and leverage for growth as the best measurement of economic returns. Let’s imagine you invoiced a customer on 30 December 2021.
However, the payment was received on 28 January 2022. It will be accounted as revenue in the financial year ending 31st December (assuming January to December financial year) 2021 under the accrual accounting method.
In contrast, in cash flow, this revenue will be considered only in the next financial year starting on 1 January 2022.
4. Business Valuation
Accounting
The approach to business valuation differs widely in both disciplines. In accounting, the assets and liabilities are captured at historical cost.
Finance
Finance considers the time value of money in high esteem. The time value of money is a widely accepted notion that there is a more significant benefit to receiving a sum of money now rather than later.
The popular technique to calculate the present value of future benefits or cash flow is the discounted cash flow (DCF) analysis. In this method, future cash flows are forecasted and discounted using the discount factor (cost of capital) to arrive at their present values (PVs).
All discounted future cash flows, inflows, and outflows give the net present value (NPV).
Here is how the DCF is computed:
Where: CF = Cash Flow in the Period, r = the interest or discount rate. n = the period number.
For example, US$100.00 in a savings account will be worth US$. 105.00 in a year at 5% annual interest rate. Similarly, suppose a delay in paying US$100.00 for a year is equivalent to a present value (PV) of US$95.00 because it cannot be invested to earn interest or return. In that case, we can calculate the PV using the above formula: 100 (cf) /(1+05 (r))^1 (n) = 95.00.
While listed companies are valued at the market cap, unlisted companies resort to various valuation methods like DCF, VC method, Revenue Multiple, Comparable analysis, and Precedent Transactions.
DCF is the ideal valuation method for startups in the early stages where revenue traction is not sufficient or comparable is not available to allow other methods.
Conclusion
Understanding the fundamental difference between accounting and finance helps you develop good financial awareness to make solid business decisions. Businesses must get an insight into their financial performance. This is in the context of external and internal factors to devise a financial strategy for business growth and sustenance.
Finance leadership can only do justice to their role with a deep understanding and expertise in accounting principles. The challenge is that most small businesses may need top-notch finance professionals to guide them. While there has been a tendency to outsource accounting or engage with virtual CFO service providers, there are other better options that you should try.
Paci.ai is a unified finance management platform for SMBs. Navigating the complicated data and constantly shifting industry intricacies in the complex realm of SMB operations can be difficult. That’s where we offer customized insights and financial advisory.
Are you looking forward to tackling the backward-looking nature of accounting with its insights and predictor modules? Don’t hesitate to contact us right now for all your financial management.
