Financial transactions are of significant importance for entities, especially for commercial businesses whose main motive is to generate profit for their owners or stockholders. These transactions involve either an inflow or outflow of funds and thus have a direct impact on entities’ profitability and financial position. As commercial entities operate, they continue performing several functions which center around these financial transactions, right from documenting, recording, reporting to analyzing and controlling. The article “accounting vs finance” looks at meaning of and differences between two of these important functions – accounting and finance.
Definitions and meanings
Accounting is the business function of measuring, recording and reporting financial transactions undertaken by an entity over a specific time period. The main objective of accounting is to determine the profitability and financial position of the entity and report the same to various internal as well as external stakeholders.
The accounting process typically involves the following processes:
- Analysis of transactions and classification of accounts.
- Passing journal entries for all financial transactions and collating relevant documentary evidence for the same.
- Posting these entries from journal to the respective ledger accounts.
- Balancing the ledger accounts and drawing up of unadjusted trial balance.
- Posting of adjustment entries and drawing up of adjusted trial balance.
- Drawing up of financial statements including profit and loss account, cash flow statement, statement of retained earnings and balance sheet.
- Closing the books of accounts by preparing a post closing or final trial balance.
While passing through the above accounting steps, an entity is required to take guidelines from a certain set of rules known as its financial reporting framework. For example, the applicable reporting framework for entities in united states is Generally Accepted Accounting Principles (GAAPs), and for entities in many other countries is International Financial Reporting Standards (IFRSs). The adoption of such accounting frameworks ensures harmonization among entities while they prepare their accounts and financial statements.
Once the accounting steps are completed and financial statements are drawn, they usually undergo a statutory audit which is determined by the applicable jurisdictional law. Once statutory audit of the books of accounts is completed, the finalized and audited financial statements are reported to various stakeholders. This completes the accounting process for an entity for a specific accounting year.
The accounting function has several branches depending on their use, information requirements of stakeholders and the nature of concerned entity. Three primary and frequently used branches are financial accounting, cost accounting and management accounting. Besides these, many other branches have emerged as a result of technological innovation and commercial development in modern industrial environment. See a more comprehensive list here.
Accounting function in an entity is performed by qualified accountants that are employed by the business entity. Entities can also outsource their accounting functions to a suitable accounting firm like KPMG, Deloitte, Ernst & Young etc. The outsourcing often enables entities to focus on their core business operations and utilize their time and other resources more productively.
Finance is the function of analyzing and managing the source as well as application of funds of any entity. The finance function typically involves the following processes:
- Evaluating and determining funding alternatives for various purposes. For example, raising capital versus borrowing funds.
- Performing its role in budgeting for expenses and monitoring adherence to those budgets.
- Monitoring financial assets and liabilities of the entity.
- Determining and monitoring the savings and investment plans for inflow of funds.
In a nutshell, we can conclude that the finance function in an entity is primarily concerned with managing its money.
When a new company is set up, it needs to determine its sources of funds. The entity needs to decide whether it should raise equity capital or approach venture capitalists. It further needs to determine whether it should borrow funds from banks or private lenders etc. The raised funds must also be efficiently allocated towards various goals and functions of the entity. As the company grows, managing and investing its earnings for effective use of its capital is also crucial. All these activities fall under the definition and functions of finance.
Finance is bifurcated into 3 broad classifications:
- Public finance: Involves management of government’s sources of income and allocations of funds for public expenditures.
- Corporate finance: Involves management of the funds of a corporate entity.
- Personal finance: Involves management of the money generated from personal sources.
Difference between accounting and finance
The ten key points of difference between accounting and finance have been detailed below:
- Accounting is the classification, recording and disclosure of financial transactions of an entity, in a systematic manner over a specific time period.
- Finance is the management function of managing the mode, manner and quantum of inflow and outflow of funds of an entity.
2. Purpose and responsibility
- The main purpose of accounting is to arrive at the profitability and financial standing of an entity and reporting the same to the stakeholders. Accounting function is responsible for ensuring financial statements represent a true and fair view of the financial state of affairs of the entity.
- The main purpose of the finance function is to efficiently manage the raising of and allocation of funds of an entity.
3. Function level
- Accounting is a business function performed by accountants.
- Finance, on the other hands, is a higher management level function performed by managers, department heads and key managerial personnel.
4. Guided by
- Accounting function is guided by the laws governing each jurisdiction. It is required to abide by statutory accounting standards and rules as set out by the respective jurisdiction.
- Finance function, on the other hand, is guided by economic principles and involves employment of various tools for assistance such as capital budgeting principles, financial models and valuation models etc.
5. Result of the function
- The outcome of the accounting function is preparation of books of accounts and financial statements, namely profit and loss account, cash and fund flow statement and balance sheet.
- The finance function results in the preparation of several MIS reports that are used by departmental heads and key managerial personnel for decision making.
- Accounting is an ongoing process which occurs almost daily in business entities. Accounting is basically performed every time a financial transaction takes place.
- Finance on the other hand is a less frequent function which is performed as and when required. For example, budgeting takes place at the beginning of a new project or new fiscal year, funding analysis takes place whenever additional funding is required.
7. Complexity and core focus
- Accounting is a less complex function as its focus is on recording and reporting.
- Finance is a more complex function as its focus is analyzing, budgeting and forecasting which requires application of higher level of knowledge, expertise and judgement.
8. Time horizon
- Accounting is a historical process as it involves financial transactions that have taken place.
- Finance, on the other hand is a forward-looking process as it involves analysis of future needs such as budgeting, forecasting, funding, investing etc.
9. Educational qualification required
- To perform accounting function a relevant degree in the field of accounts is desirable. For example, CPA.
- To perform finance function, degree in the field of economics, finance, business management etc. is desirable. For example, MBA (Finance).
10. Statutory check
- Efficacy of accounting function is checked by auditors. This is generally required by statute.
- Finance function is an internal management function and does not require any statutory check but is in fact monitored internally by higher level managerial personnel.
While several differences exist in the nature of processes involved in an entity’s accounting and finance functions, both have one important common thread. They both play an important role in decision making. For example, financial accounting helps stakeholders and investors assess creditworthiness of the entity and cost accounting helps entities with pricing and cost control strategies etc.
Finance function assists in decision making like determining the most appropriate modes for raising funds, the best investment avenues and drawing up of budgets etc. Both the functions are thus critical for smooth and successful operation of any business entity.