What is the Difference Between Finance and Accounting?
Finance and accounting are two of the most common business degrees. Whether you decide to major in one or the other depends on what your goals are and how well the degree matches them.
Both careers involve working with numbers and require strong financial understanding to make sound business judgments. However, the two professions differ in scope and concentration.
Financial Statements
Financial statements provide information about an organization’s financial position and performance during a specific time period. They include an income statement, balance sheet and cash flow statement. Finance professionals use these statements to make informed decisions about a company’s future and to ensure that the business can meet its obligations.
In the United States, the accounting standards known as Generally Accepted Accounting Principles (GAAP) are used to prepare these reports. These rules provide guidance on when to record revenue and expenses, which accounts are to be included in the financial statements, and how to present them.
The most important part of a financial statement is the balance sheet, which lists the assets and liabilities that a company owns or owes. It also shows any remaining difference between the two amounts.
Another important part of a financial statement is the income statement, which details all of the revenue that a company receives and the expenses that it incurs in earning that revenue. It also includes any earnings that the company may have accumulated during the year, such as retained earnings.
Expenses are incurred during the course of business activities that generate revenue, such as sales, marketing, and administrative costs. These include employee wages, sales commissions, and utilities like electricity and transportation.
Other common expenses are associated with secondary activities, such as research and development (R&D), depreciation or amortization of owned assets, and interest on debts. Some expenses are considered cash outflows, such as the sale of assets that are not being held by the company.
The financial statements of large corporations typically include supplementary notes that explain the details of the financial statements in more detail. These notes also help to support the valuations that have been computed on particular account lines.
These statements are essential to owners and managers, who need to know the financial status of a company in order to make strategic decisions about its future. They also provide prospective investors with a detailed understanding of a company’s financial condition, allowing them to assess whether or not to invest in it.
Assets
Assets are the items that you own, and liabilities are the debts you owe. These two concepts are often confused, but they are actually quite different. In the business world, assets help to produce goods and drive growth while liabilities are used to finance these activities.
A company’s total assets are the cash, stock, property and equipment that it owns. These are listed on the balance sheet and grouped according to their liquidity, or how quickly they can be converted to cash.
Liabilities are the debts a company owes to other parties. These can include loans, credit card balances, payroll taxes and accounts payable. These are all recorded on a company’s balance sheet and can be easily seen by creditors and investors alike.
Companies account for assets based on how easily they can be turned into cash and whether they are tangible or intangible. Intangible assets, like patents, copyrights and trade secrets, are harder to sell, but they can also be very valuable.
You can also classify assets by their usage. Operating assets are the ones that you use to generate revenue and maintain daily operations, such as inventory or factories. Non-operating assets, on the other hand, are not necessary for everyday operations but still have value.
For example, a business that makes disinfectant devices for smartphones might have a long-term asset in the factory where they make the products. This is because the factory is likely to be in use for many years, and a company would need to borrow money to buy it.
The assets and liabilities of a company are important when it comes to gauging its liquidity, debt repayment capability and profitability. This helps intending investors understand how well a company is running and makes it easier to decide if a company is a good investment.
The most obvious difference between assets and liabilities is the amount of money a company has. For instance, a bakery that has $1,000 in inventory is an asset because the store could sell the items for that much. On the other hand, a company that has credit sales of $1,000 each month is a liability because it has to pay customers in the future.
Liabilities
In financial terms, liabilities are money owed. They can be current (due within one year) or long-term (need to be paid over a longer period).
Assets are items that a company owns, like inventory and cash. These assets have a value and can be used to generate cash flow, reduce expenses or provide future economic benefits. They also help a company build equity and increase its worth.
Liabilities can include loans and other debts that need to be repaid, as well as legal obligations. They can also be payments that a business is required to make as part of its operations or in order to expand and acquire new equipment.
Most businesses have several types of liabilities, including short-term and long-term debts. They need to keep track of both of these categories to determine if they have enough liquidity, or the ability to meet their immediate and short-term needs, for outstanding debts.
Short-term liabilities are ones that must be paid in the near future, like bills and overdraft fees. These can affect a business’s daily operations, so they should be monitored closely.
Some short-term liabilities include upcoming credit card payments, bank overdraft fees, tax liabilities and accrued wages. Others include upcoming supplier payments and upcoming mortgages.
Long-term liabilities are those that take longer to repay, such as deferred taxes or long-term bonds. These are important to keep track of, as they can help you decide whether or not you need to raise funds through a loan or other means.
Contingent liabilities are obligations that depend on the outcome of a future event, such as a lawsuit. These can be significant to a company, as they might result in an unexpected amount of money being owed to the business.
Ideally, the total amount of assets on a company’s balance sheet outweighs its liabilities. This can make it easier to build equity, pay off debts or pursue other financial goals, as well as avoid a solvency crisis that requires the organization to seek outside financing.
Cash Flows
Cash flow is the money that moves between a company and its owners, investors and creditors. This is a crucial indicator of the financial health of a business and how well it can generate value for its shareholders. A positive cash flow must be maintained for a company to remain in business, while a negative cash flow can negatively affect its ability to generate value for its investors.
There are three components of a cash flow statement: operating cash flow, investing cash flow and financing cash flow. The first component, cash flow from operations (CFO), reports cash flows and outflows resulting from a company’s core operational activities such as buying and selling inventory, paying employees, and making rent payments.
The next component, investing cash flow, measures the amount of money that a company receives or spends to purchase assets or stocks and/or pay off loans. This is an important source of capital because it allows the company to invest in its future operations and growth.
Finally, financing cash flow consists of the money a company raises through debt and equity financing activities. This includes receipts and payments from issuing common stock, preferred stock and bonds as well as borrowings from banks or equity investors.
While both accounting and finance can be valuable to a company, there are certain key differences between the two disciplines. For instance, while accounting employs a conservatism principle in which companies record lower projected values of their assets and higher estimates of their liabilities, finance rejects that philosophy and instead uses an analytical process called valuation to determine the value of a company or project.
Another difference between the two disciplines is that cash flows are a better measure of profitability than net income. As a result, cash flow analysis is often used to evaluate the quality of income generated by accrual accounting concepts, such as those involving large non-cash items.
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