People tends to see Accounting and Finance as two different words for the same thing that have the same functions or mixed in some points.
While it is true that Accounting and Finance live under the same roof and share many same things in common, these are TOTALLY two different things; two different functions, two different goals, two different group of players, and require two different educations and skills, which I will discuss further in this post.
This topic, as far as I know, has been discussed a lot over the internet. Go open your browser and search “accounting versus finance” or “accounting vs finance” or “difference of accounting and finance,” and you will see lots of link popup that go to websites or blogs discuss this topic, from a thin paragraph to an extremely long post. If you get the answer, great.
But if you still confuse or cannot get the point, then keep reading this post as I am going to show you the exact difference of Accounting and Finance, in a practical perspective.
In addition to that, I am also going to show you what the function and the goal of each Accounting and Finance in within the same business, so that you can see the difference clearly.
But first, let’s have a look at the misconception a little bit deeper and how it could create serious trouble in some areas.
How A Serious Misconception Creates Trouble
A serious misconception persists in the public’s view about accounting and finance. Both are often thought as to work for the same functions. This misconception could create confusion and often causes serious problems in two major areas:
1. Career Area – It is often that a student wants to become a banker mistakenly takes Accounting as a starting point because of the misconception. Right after the graduation, she applied for a Credit Officer position in several different banks. But, somehow, none of the banks called her in for an interview, and she started to think “what is wrong with my job application?”
Nothing is wrong. The only problem is that her education background does not match the position that she has applied; the bank wants Management graduate whose focuses on Financial Management for the Credit Officer position, not Accounting! Just if she applied for Accounting position (a Cash Accountant for example,) the bank might call her for an interview.
A similar situation could also become the case of those who wants to become an Asset Manager or a Financial Analyst.
All of them supposed to take ‘Management’ which focuses on ‘Financial Management’ as a starting point, NOT Accounting!
It sounds tragic that people spent years (and probably lots of money as well) for a wrong educational investment but, these clearly shows us how bad such misconception could affect people.
2. Business Area (the Internal Control) – Particularly on the small and medium businesses, it is often that some accountants also conduct financial functions; OR some finance staffs also perform accounting functions. For example:
- A Cashier (Finance) disburses cash and makes payment slips, ALSO record the transactions that supposed to be done by a Cash Accountant (Accounting.)
- An Accounts Payable Accountant (Accounting) records payable but, before that, he ALSO issues receiving slips that supposed to be done by a Warehouse Staff (Finance.)
- A Warehouse Staff (Finance) sends merchandise out to customers and create invoices, ALSO record receivable for the transaction that supposed to be done by an Accounts Receivable Accountant (Accounting.)
Such practices could go untold for quite long. With an assumption that accounting and finance are just two different words with the same meaning, they think both functions can be done by the same staff.
It isn’t uncommon that even the management can’t distinguish the functions of accounting and finance so they don’t see any problems until an external auditor catches the problem and tells them that such practices could expose the company to various fraud risks. Or, in the worst case, a massive fraud has happened first and a fraud examiner reveals the source of the problem (accounting’s and finance’s functions done by the same staff.)
On the evaluation process, the business owners probably admit that they stuck in a situation of having no ability to hire more staffs. While the reasoning makes sense (capital constraint), an auditor/examiner can enlighten further by comparing ‘the cost of hiring more staffs’ -AND- ‘the risks of having a weak internal control,’ and propose a suggestion.
But before that, especially on medium businesses where capital isn’t a constraint, he should also point out the root of the problem lies behind the reason; the misconception!
I write this article (as a part of the introduction series) with a hope that you will get a better perspective about accounting and finance in general.
While it is true that Accounting and Finance share many same things in common, there is the fundamental difference between the two, which I am going to share through this post. Let’s start with the similarities first.
Similarities of Accounting and Finance
Here are similarities of Accounting and Finance:
Worked in Within Business Area – Both Accounting and Finance existed and worked in within the business area. Meaning that both two could affect the business, on the first hand. And both two are also affected by the characteristic of the business (i.e. the complexity of each is affected by the forms, scales, and lines of the business,) on the other hand.
2. Related to Numbers – Both Accounting and Finance related to numbers. Meaning that both worked on numbers, both make calculations, both focused on details, and both aim for accuracy.
3. Worked on Financial – Both Accounting and Finance worked on the financial aspect of the business or organization only. Other aspects of the business such as human, public image, legal, and etc., are beyond the scope of Accounting and Finance.
4. Related to Money – Both Accounting and Finance related to money. Meaning that both two doing things with money in mind. Every single task performed and every single decision made is related to money or other types of asset. Any inaccuracies or mistakes made on any of the areas could lose money or other assets.
Next, what is the fundamental difference of Accounting and Finance?
Fundamental Difference of Accounting and Finance
Accounting and Finance have different function and different goal, even though worked under the same roof of a business. In plain English (see the bolded words below):
*Finance manages the money (and other assets) in an effective manner that will generate more money come back to the business (called “Profit”) and then to its investors (called “ROI=Return-on-Investment.”)
*Accounting measures the effectiveness of the management of the money conducted by the Finance toward profit-making and ROI-making process.
Can you see the difference?
Let’s split the functions and the goals.
* Finance is a manager (of money and other assets.)
* Accounting is a measurer (of money and other assets.)
And the goals:
* The Finance’s goal is effective management of money (and other assets) that generates profit and return-on-investment.
*Accounting’s goal is accurate reports that reflect the actual position of the money (and other assets) managed by the Finance; what profit and return-on-investment have been made so far.
Now, up to this point, you may get an impression that the Finance works under the supervision of the Accounting. No, this is not the case. And viewing the exact opposite is also not correct.
On the chart of organization, the Accounting Dept is managed by a Chief Accountant, while the Finance Dept is managed by a Finance Manager. The Chief Accountant reports to a Controller while the Finance Manager reports to a Treasurer.
Both Controller and Treasurer report to the Chief Financial Officer (CFO,) an executive position that takes care the financial aspect of the business and has the responsibility of generating the expected profit and ROI in within the business’s operation.
So, in within the same business and under the oversight of a CFO, the Finance and the Accounting Dept are equal, both two work hand-in-hand to reach the goal of making profit and ROI:
- The Fìnance is given the main responsibility for managing the money and other assets through its financial management process (planning, executing and evaluating); and
- The Accounting is given the main responsibility of tracking the flow of the money through its accounting process (identifying, calculating, recording, classifying, reporting, analyzing, and interpreting.)
Let’s elaborate these a little bit more with a case example so that you can see how the Accounting work hand-in-hand with the Finance.
How Accounting and Finance Work
A business activity can be broken down into several stages that go cyclically. The cycle of the business activity called “business cycle.” Likewise, the work of Accounting and Finance also go cyclically following the business cycle, as follows:
1. Planning stage
The business activity is always started and led by a solid business plan. In the case of an established business, the activities are led by an annual forecast. Using the plan/forecast, each department in the business makes its own departmental budget called “Operating budget.”
Finance: Using the operating budgets of all dept, the Finance Dept then makes “Financial Budget.” In a nutshell, the Financial Budget pretty much tells its user about what activities will be made, how much money is needed for each activity, and how much money will come back to the business as a result of the activities.
Accounting: Using the Financial Budget the Accounting Dept generates a report called “Budgeted Financial Statements.” In a nutshell, the budgeted financial statements consisted of:
(1) ‘Budgeted Income Statements‘ that tells the users about what amount of revenue to be expected, what costs occur to generate the revenue, what operating expenses will occur to keep the business running smoothly, and what profit earning to be expected as a bottom line at the end of the business cycle;
(2) ‘Budgeted Balance Sheet‘ that tells the users about the value of assets, liabilities, and equity that can be expected at the end of the business cycle;
(3) ‘Budgeted Statement of Cash Flow‘ that tells the users about cash in and cash out from the operating, financing and investing activities run by the business during the cycle.
The Accounting will use the budgeted financial statements to measure the effectiveness of the management of money and other assets conducted by the Finance Dept.
2. Executing Stage
Finance: Using the Financial Budget the Finance Dept prepares the money needed for funding all business activities (operating, financing and investing.) In the case of sort of money, the Finance Dept should seek the source of the money whether it is a bank loan or sales of share. The department should run some analyses to determine which source is more cost effective. On the first hand, the Finance Dept started to disburse the money as it is required (i.e. machines and tools purchase, products and services purchase, payroll and wages payment, payable payment, investing in other business, bank loan installment and interest payment, and etc.) Other than disbursing cash, the Finance Dept also collects money from customers and cashes out money from a bank loan that available for usage. The Finance Dept has to make sure that every penny is used in an effective manner following the Financial Budget.
Accounting: The Accounting Dept run the accounting process (identifying, calculating, recording, classifying and reporting) for every single transaction occur during the business cycle following on the activities made by the Finance Dept. At the end of the process, the Accounting Dept generates the Financial Statements that reflect the actual profit/loss position as a result of the business activities (the Income Statements), actual value of assets-liabilities-and-equity belong to the business, including cash (the Balance Sheet,) and actual cash in and cash out in total for the cycle (the Cash flow Statements.)
3. Evaluating Stage
Accounting and Controller: At the end of the business cycle, whether it is monthly, or quarterly, or annually, the Accounting generates official Financial Statements and issue the report for the users, i.e. the internal management, the investors, the creditors, and the government. To conduct an evaluation process, the Controller compares the Financial Statements with the Budgeted Financial Statement that was generated in the planning stage. And with the help of a Management Accountant or two, the controller also generates a report called “Key Performance Indicator” (KPI) report which tells the CFO about how effective the management (including the Finance Dept) use all sources belong to the business for that cycle.
Finance and Treasurer: As part of the internal management users, the Finance and the Treasurer use the Financial Statements to run various financial analyses (mainly: profitability, liquidity and solvency analyses) for its own use on the next cycle.
CFO: Reviews the report that was generated by the Accounting and Finance Dept and see whether the business reached its goal in an effective manner or did not.
That is how activities planned, executed, and evaluated, at the financial aspect of the business, and how the Accounting and Finance work hand-in-hand to reach the goal of making profit and ROI.
Next, by using the evaluation analysis and report, a new cycle will be started from the planning stage again.
1. Accounting and Finance are not only two different words but totally two different things that have two different main functions thus require two different skills/expertises.
2. Those who wants to become a banker or a financial analyst should study Financial Management instead of Accounting. Studying Accounting is best for those who wants to become an Accountant.
3. A Small Business owner may have the constraint of hiring more staffs but letting the Accounting’s and the Finance’s functions conducted by the same staff is dangerous. Compare ‘the cost of hiring more staffs’ WITH ‘the risk of having a weak internal control’ instead, and see which one is best for you.
4. Accounting and Finance are worked on the financial aspect of the business, both two are related to numbers and money but, they are two different depts with two different functions; the Finance is a manager of money (and other assets) and the Accounting is a measurer of the money (and other assets) managed by the Finance.
5. On the Chart of Organization, the Finance dept is Managed by a Financial Manager whose then reports to a Treasurer. The Accounting Dept is managed by a Chief of Accounting whose then reports to a Controller. Both Treasurer and Controller report to an executive called “Chief Financial Officer.”
6. Under the oversight of a CFO, Finance and Accounting are worked hand-in-hand on the financial aspect of the business, along with the business cycles, through the planning-executing-and-evaluating processes.
7. At the beginning of the business cycle, the Accounting generates ‘Budgeted Financial Statements’ based on the Financial Budget made by the Finance Dept. Once the planning stage is completed, the Finance executes the Financial Budget (cash disbursement-collection) and the Accounting is started to run its own process (identifying, calculating, classifying, summarizing and reporting) every single transaction made by the Finance and other departments. At the end of the stage, each the Accounting and the Finance generate evaluation reports. The reports then are submitted to the CFO.