In this post, I am clarifying the difference between accounting and finance to help business owners and entrepreneurs better navigate the development of these key functions in their emerging businesses. Accounting and Finance are important for a business’s success, but they have subtle differences that can sometimes confuse entrepreneurs. Understanding their similarities and differences will help business owners know when they need both services and whether they are relevant to their business. Let’s dive into the topic.
Accounting: Categorization of Financial Events
Accounting is the maintenance and reporting of a company’s financial records through the correct categorization of financial events in the business. It involves recording, classifying, and reporting financial transactions and ensuring that financial records are accurate and compliant with the standard of accounting you seek – generally this means cash accounting or accrual accounting. Businesses are, by law, required to keep accounts and records of financial statements for taxation purposes, and cash accounting is suitable and the easiest way to go about this. Once you have investors involved in your business, it might make sense to switch to accrual accounting.
Accounting focuses on capturing a company’s financial information at a particular point in time. Usually monthly, quarterly, or annually. Sometimes, weekly accounting is needed to manage tight cash flow, but I don’t view this as accounting, it’s cash flow management that depends heavily on the occurrence of revenues and expenses on a weekly basis which you will find in the accounting records.
A basic principle of accounting is that Assets = Liability + Owner’s Equity. This formula looks at what a company owns (its assets), what it owes (its liabilities), and the residual that belongs to shareholders (owner’s equity).
What is Finance?
Finance is managing the future development of your business financially. Finance involves analysing financial data for strategic investment decisions, budgeting, and risk management. Finance is the strategic management and planning of money over time, focused on optimizing future financial outcomes through investment, funding, and resource allocation decisions. Financial decisions usually cover Capital Structure, Investment Criteria, Risk Management, and Value Creation.
A basic principle of finance is that Risk and Return are related. This principle states that higher potential returns require taking on more risk, and investors must be compensated for taking additional risk. To summarize, finance involves analyzing financial opportunities and risks to make decisions that maximize value creation, which drives the value of your business and makes it have value to a buyer in the future.
While accounting looks backward to record what happened, finance looks forward to planning what should happen. Businesses need finance to grow and make strategic choices about using their resources – generally this means deciding between investing in growth, paying down debt, or returning capital to owners. Basic financial decisions revolve around three key areas: investment (where to deploy capital), financing (how to fund operations), and dividends (what to return to shareholders).
Finance focuses on making decisions about a company’s financial future based on both current data and projections. Usually these decisions cover short-term (operational), medium-term (tactical) and long-term (strategic) horizons. Sometimes short-term financial decisions are confused with accounting, but I view this as treasury management which depends on understanding both accounting records and future cash flows.
Similarities Between Accounting and Finance
The key similarity between accounting and finance is that both have to do with MONEY. They involve recording, analyzing, reporting, and projecting a business’s cash flow. Both accounting and finance, keep track of the assets and liabilities of a company, and are aimed at increasing the profitability and valuation of a business.
Accounting and Finance require similar technical and non-technical skill sets, as well as a keen attention to detail. In terms of career path, accountants and financial analysts can work in similar roles, such as commercial and investment banks, real estate finance, mortgage banks, insurance, or directly serve businesses.
Both can serve individuals, businesses, and the government. But, you should not confuse the capabilities of an accountant to handle finance work and vice versa. However, in my experience, I have found it more likely that a strong finance professional can handle accounting issues than the other way around. Not in every case, but most of the time I have found this to be true as finance inherently involves accounting but you can do lots of accounting without ever having to handle any strategic finance questions or problems.
Differences between Accounting and Finance
The main difference between accounting and finance is that accounting focuses on the past, while finance focuses on the future. Accounting professionals are more focused on professional principles and processes, while finance involves creativity and innovation to think out ways a company can grow profitably.
Accounting focuses on the day-to-day flow of money in and out of a company, while finance is a broader term for managing assets and liabilities.
Accounting focuses on the day-to-day management of financial reports and records in the business world, while finance uses the same information to analyze transactions and project future growth.
When assessing performance through the lens of finance, cash is king. Unlike accounting, which relies on transactional data, finance examines how effectively an organization generates and uses cash through several measurements. They examine how much money a company has to distribute to investors or reinvest after covering all expenses.
Which is more important?
Can you drive a car without a windshield or rearview mirror? Just as we would need vision of what’s in front of us as well as what’s behind us while driving, accounting and finance are equally helpful for a business. Financial decisions are based on accounting information and accounting using feedback from finance to monitor cash flow.
In accounting, a conservatism principle is often applied, which suggests that companies should record lower projected values of their assets and higher estimates of their liabilities. In contrast, finance employs an analytical process known as valuation to determine the worth of a company, project, or asset. This is the basis for the valuation of start-ups and Venture Capital funding.
Case Study of Accounting in a Business
LightGreen Taxi Rental is a taxi and fleet management business that operates in a local suburb with five (5) contract employees and five (5) vehicles.
Background
Sarah started the business 5 years ago with a small loan from her family. Initially, she managed finances informally, relying on intuition. However, as the company grew, she realized the need for structured accounting. To address these challenges she hired an accountant.
Accounting Challenges
- Cash flow management: Sarah struggled to track income and expenses and manage cash flow effectively.
- Financial reporting: Lack of organized financial records hindered her ability to assess business performance.
- Tax compliance: Inaccurate financial records led to delayed tax submissions and fines.
- Budgeting: Sarah found it difficult to create realistic budgets without accurate financial data.
Key Contributions of the Accountant
- Accounting software: Adopted cloud-based accounting software (QuickBooks) for efficient financial management.
- Bookkeeping: Implemented regular bookkeeping practices to track transactions.
- Budgeting and forecasting: Created detailed budgets and forecasts.
Benefits
- Improved cash flow management: Accurate financial tracking enabled informed decisions.
- Enhanced financial reporting: Regular financial statements provided clarity on business performance.
- Tax compliance: Timely and accurate tax submissions avoided penalties.
- Informed decision-making: Data-driven insights guided expansion and investment decisions.
- Increased profitability: Better financial management resulted in a 25% profit increase within a year.
Case Study of a Fractional CFO
Background
After implementing accounting practices (as seen in the previous case study), Sarah, owner of LightGreen Taxi Rental, sought strategic financial guidance. As her business grew, she faced challenges in managing growth, optimizing finances, and exploring expansion opportunities. Sarah hired a Fractional CFO for 20 hours/month, to provide strategic financial leadership.
Financial Challenges
- Strategic financial planning: Lack of long-term financial strategy hindered growth.
- Financial analysis: Limited expertise in detailed financial analysis.
- Funding exploration: Uncertainty about accessing capital for expansion.
- Risk management: No comprehensive risk assessment.
Key Contributions of the Fractional CFO
- Financial strategy: Developed a 3-year financial plan aligning with business objectives.
- Financial analysis: Conducted in-depth analysis to identify areas to drive profitability by understanding the break even points for cars and drivers.
- Risk assessment: Implemented risk management strategies by using vehicle tracking data to improve driver performance and extend the asset life..
- Budgeting and forecasting: Enhanced budgeting and forecasting processes to provide lenders with a view of how the business grows with their capital invested into vehicular assets and driver training..
- Key performance indicators (KPIs): Established financial and operational KPIs to keep ridersm drivers, routes and vehicles tracking to the overall value creation plan in the financial forecast..
Benefits
- Strategic clarity: Aligned financial strategy with business goals.
- Cost optimization: Identified areas to improve business savings.
- Risk mitigation: Implemented strategies protecting against financial risks.
- Improved decision-making: Data-driven insights inform business decisions.
- Growth acceleration: 30% annual growth within 2 years.
FAQs
Q1: Why should businesses engage a Fractional CFO in addition to an accountant?
A1: The Fractional CFO can help facilitate annual growth, optimize finances and explore expansion opportunities.
Q2: What benefits can businesses derive from the Fractional CFO engagement?
A2: Key benefits included development of a 3-year financial plan, cost optimization, securing funding for expansion, risk mitigation strategies and improved decision-making through data-driven insights.
Q3: How does a Fractional CFO arrangement support long-term sustainability?
A3: The engagement of a Fractional CFO is an affordable way for businesses to gain strategic financial leadership, without the commitment of a full-time CFO. And, this would enable the company to navigate growth challenges, optimize resources and make informed decisions, ensuring long-term sustainability and continued success.
So, Why Choose CFO Pro + Analytics for Your Fractional CFO Needs?
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About the Author: Salvatore Tirabassi is a seasoned Chief Financial Officer and change agent with over 24 years of success transforming finance to innovate, grow, and increase shareholder value. Based in or operating out of the New York City area, Salvatore specializes in providing Fractional CFO services to businesses, offering strategic financial guidance to drive growth and success. Connect with Salvatore on LinkedIn or CFO PRO+Analytics for more insights on financial management and strategic planning.
