Finance vs Accounting: Unraveling the Difference

As a small business owner you probably hear the terms accounting and finance used interchangeably. While they are closely-related and often overlap, the functions and skillset of the roles are distinct. Understanding the ways they vary will allow for you to understand the financial function of your business. Lets explore each a little bit further.

What is Accounting?

Definition and Purpose

Accounting is the systematic process of recording, classifying, summarizing, and interpreting financial transactions. The primary goal of accounting is to provide accurate financial information to stakeholders, including business owners, managers, investors, and regulators. They also handle compliance such as tax obligations or other regulatory obligations.

Key Functions of Accounting

        1.      Recording Transactions: Each time your business sells, purchases or enters a contract, a transaction has occurred. Accounting involves the recordkeeping of each of these transactions.

        2.      Classifying Transactions: Each transaction a business enters is grouped into a broader class. Accounting involves interpreting each transaction for appropriate classification, such as revenues, expenses, assets, and liabilities.

        3.      Summarizing Financial Data: Accountants will utilized the group of classified transactions to compile financial statements. Financials statements are interpreted by business stakeholders (owners, investors, bankers, etc.) to understand the Company's health and overall performance. Financial statements include the balance sheet, income statement, and cash flow statement.

        4.      Interpreting Financial Information: Analyzing financial data to help stakeholders understand the business’s financial position and performance. Analyzing this financial data allows business owners to understand the business' liquidity, profitability and leverage which are key to making informed decisions in both operating and capitalizing the business.

        5.      Managing compliance with government agencies, bank requirements, etc. There is no getting away from it, most every business and individual is required to file taxes with at least one governmental agency. For businesses that have borrowed from financial institutions, certain reporting may be required.

Skill Set

Accountants typically possess strong attention to detail, analytical skills, and a deep understanding of accounting principles and standards.

What is Finance?

Definition and Purpose

Finance is the science and art of managing money. It involves planning, raising, investing, and managing funds to achieve the financial goals of an individual or organization. The primary focus of finance is on the management and allocation of assets and liabilities over time under conditions of varying degrees of uncertainty and risk.

Key Functions of Finance

        1.      Financial Planning and Analysis: Often referred to as FP&A, this involves forecasting future financial performance to allow for adequate resource planning.

        2.      Investment Management: Involves the assessment of various investment options to achieve the highest returns while also considering the individual's or business' risk tolerance.

        3.      Risk Management: Determining appropriate risk tolerance and identifying, assessing, and mitigating financial risks.

        4.      Capital Structure Management: Businesses often require capitalization through debt or equity. Finance involves determining the optimal mix of financing options and educating business owners of the cost/benefit of these various options.

Key Areas

        •       Corporate Finance: Includes a company’s financial activities, such as the use of capital, raising capital through debt or equity, investment decisions, and financial strategy.

        •       Personal Finance: Managing all financial decisions and activities of an individual or household, such as saving, investing, insurance and mortgage planning and planning for retirement.

Skill Set

Finance professionals typically possess strong analytical and quantitative skills, a deep understanding of financial markets and instruments, and the ability to make strategic decisions under uncertainty.

In Summary

        •       Accounting: Focuses on the past and present financial transactions, ensuring accurate recording and reporting for the purpose of decision-making and compliance.

        •       Finance: Looks forward, focusing on future financial planning to optimize the use of financial resources, maximize returns, and manage risks.