The Difference between Accounting and Finance
In this video, I discuss this age old question. What’s the difference between Accounting and Finance?
VIDEO SUMMARY
This video is about the difference between accounting and finance. I am making this video because there is a lot of confusion out there about the difference between these two roles. A lot of people in business do not know the distinction. In business school, these are two separate areas of study. So you will go to school and you will either learn how to become an accountant or you will learn how to become a finance person. They both they use two different tools and skill sets on how to accomplish their goals. So I think it is important to understand the distinction between these two areas. Now in this video I am going to talk in pretty large generalizations. Every organization is different so this is not going to apply exactly to everybody’s organization. But in general, when we talk about the accountant role and the finance role in an organization, I think it is useful to understand the distinction.
So in general, what makes the difference between an accountant and a finance professional? Accountants are primarily concerned with the goal that is historical looking. This is different from finance, because in finance the goal is future looking. So what does that mean? Well let us start with the accounting. The goal of accountants is to create a set of financial statements that represent accurately the financial standing of a company at some moment in time. So they look at the economic transactions that have occurred up to this point, they look at how much cash is in the bank today, and they say “how did we get here?” They create a set of financial statements that accurately represents that. Now this is easier said than done, and accountants deal with all kinds of really complicated problems. They have also found ways to solve those problems. When you have a really complicated organization, you have hundreds of employees and thousands upon thousands of transactions. You get all kinds of errors. You get returns and you make sales that might have returns in the future, so you have all these complicated situations. Accountants have ways to represent those accurately and do it in a way that is standardized across the nation. So you can take accounting statements from two different companies and make investment decisions.
Finance, on the other hand, has a future oriented goal. Finance people start with the financial statements from the accountants. They say, “okay, this is how much cash we have in the bank today. This is how we got there. What are our assumptions about what is going to happen in the future?” And then they take those assumptions and that informs the business decisions we make about how we are going to use the cash today.
Why this is important is because there are two different goals that inform two different definitions of risk. It is funny because when you get an accountant and a finance person having a conversation about risk, it is almost like they are talking about two different things. It is because they are. When an accountant talks about risk, they are concerned with the risk of material misstatement of the financial statements. So they are concerned that somehow something is not being represented accurately. It is the accountant’s job to represent all the historical transactions that actually occurred. So that is the risk they are concerned about. They are always trying to minimize that risk as much as possible. Finance people have a little bit of a different relationship with risk. There is a little bit more of embracing risk in finance because finance deals with the future. It has not happened yet. Nobody can predict it a hundred percent accurately. So there is always going to be an element of risk there. The finance definition of risk is the variance between the assumption about the future and what actually ends up happening. That is the risk that they are concerned about. This risk is really important to a finance person. If you remember from my earlier video on the time value of money, risk plays a really big role in determining valuations. Based on the risk that you are assuming, that plays into how much you should be compensated for holding that risk. The higher the risk, the higher the return. So for a finance person, it really becomes about managing your risks. So these are these are two very different conversations, and they come with two very different skill sets.
I have been describing the differences in the context of a corporate environment.
But probably the biggest area of finance deals with investing. Investing is its own unique area of finance. But it is really the same situation. Investors are looking at different companies and they start with the financial statements from the accountants. And they say, “This is how much cash is in the bank. This is how the companies have performed up until this date. What are my assumptions about the future, and where am I going to put my money to get the best impact in performance in the future.” So that is investing which is a specific area of finance. But in the context of an organization, what I want to emphasize is that both of these roles are incredibly important to have a strong skill set in. So most organizations have a similar setup where you have the CEO at the top. Underneath him or her, you will have the CFO. And under the CFO, you will have the head of accounting and the head of finance. The head of accounting might be the controller. Every organization is different, but that is a pretty common set up. For that CEO, it is really important to have both of these skill sets, because the business leader needs to understand both what has been the company’s performance historically up into this point and what is the understanding of how to get the best performance in the future. What business decisions need to be made today that are in the best interest of the company? So both of these skills really play into that.
So to recap, we talked about the difference between accounting and finance. They have two different goals. Accounting is focused on the historical whereas finance is focused on the future. And because there are two different goals, that informs two different definitions of risk.
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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.