Established in the Tax Cuts and Jobs Act (TCJA) of 2017 under Section 199A, the Qualified Business...
4 Key Differences between Accounting & Finance
While many small businesses use accounting and finance interchangeably, they are two separate and distinct functions. It's important for businesses to know the difference between the two because it is often the difference between whether you are focusing on past performance or future expectations. Most businesses recognize a need for accounting solutions early on due to the need for compliance. Taxes must be filed with the appropriate taxing authorities. Financial statements must be delivered to creditors. And there are a great number of professionals who can provide solutions to keep your business compliant. Finance solutions, on the other hand, are generally adopted due to internal demands for growth and scale. The talent pool with this skillset is much smaller than compliance work and generally come at a higher rate.
To help you understand the difference between accounting and finance, this article lists four key differences between accounting and finance. Reach out to us when you are ready to learn how an internal finance function can support the growth and scale of your business.
Difference #1: Objective
The primary objective of the accounting function is to report to a standard. Accounting ensures your profit & loss statement used for the tax return is in accordance with the rules of the relevant taxing authority. Accounting also prepares your financial statements for use by creditors and other stakeholders in accordance with generally accepted accounting principles (GAAP). This reporting gives a snapshot of the company and is often used to provide some support to the company’s ability to remain in business for the next year.
The primary objective of the finance function is to drive business performance. Whereas the financial statement is the primary end product of accounting, the financial model is the end product of finance. Instead of a focus on reporting, finance spends the majority of its time in analysis.
Difference #2: Capital Emphasis
Accounting emphasizes the historical reporting on capital. Because of the basic accounting equation (Assets = Liabilities + Equity), it attempts to identify and categorize where all the capital IS. Because these financial statements are primarily for the benefit of external users, this capital reporting is heavy on standardization. Banks, investors, and analysts all want everyone to do it the same way for the purposes of comparison. Why? Because they want to be able to make statements like those below to help them or their clients decide where to put their money.
- Company A has a better debt to equity ration than Company B.
- Company C has a healthier cash position than Company D.
- Company E has a higher return on total assets than Company F.
Finance emphasizes the future allocation of capital. While historical reporting is relevant to the discussion, it is but one piece to the puzzle. The accounting can tell you that that Company C has a healthier cash position than Company D. It probably can even tell you that the reason is because Company D has spent its cash on investment in research & development. However, finance will be able to tell you that the expected return on that investment is X% over Y period based on Z assumptions. If accounting answers the question, “Where did you spend money?”, finance answers the question, “Why did you spend money?”
Difference #3: Use of Data
Everything in accounting comes down to quantifying aggregate numbers in the general ledger. (And if you’re using your GL system as a research tool for data, you’re doing it wrong.) Operational systems are important, but only as they are needed to record transactions for the purposes of recording them into the general ledger. The biggest win for accounting technology is that it automates as much of the process of getting those transactions into the general ledger with minimal possibility for error. Solid controls lead to greater comfort that those financial reports follow the rules and guidance in place.
The technology finance uses should qualify the data. The tools will be explanatory and exploratory in nature. Instead of looking at aggregate data, finance wants to look at detailed data from the variety of systems in a business in order to tell the story of why things happened and what will happen if we do things differently. In order to do so, financial data from accounting is combined with operational data from the business units to put it all together.
Difference #4: Tendency
Accounting likes certainty. Every penny must be accounted for. If the reconciliation of a $1M account is off by $100, it must be tracked down. Apart from the estimates used in financial accounting more prevalent in larger companies (e.g., A/R collection rate, contingent liabilities, credit loss allowances), there is always one answer. And one answer only. If you talk to an accounting professional, they will be precise and granular.
Finance likes estimates. About, around, and somewhere near are beloved words and phrases. Chasing down dollars and cents are a waste of time because the point of the reporting is not determining the precise number. Because finance often looks at the future, it is understood that whatever number is placed on the paper is guaranteed to not be the final number. The goal is to understand the range of possibilities and what it will take for the company to achieve the most desired scenario.
So...which one is better for you as a business? Neither, because they are both important. Because you have to pay taxes and need to be able to present solid financials for capital funding, you need a strong accounting function to make sure there are no troubles there. However, a strong accounting function is just the foundation of truly growing and scaling your business. You will eventually need to layer on finance functions like cash flow forecasting, budgeting/forecasting, and variance analyses in order to support the business decisions you need to make. Don't worry though. We'd love to walk alongside you on the journey. Reach out to us to find out how.