Finance and Accounting are often used as synonyms.
Majority of Business Schools – at least in the UK – also have combined Finance and Accounting departments. Only a handful of schools maintain separate departments.
Degrees in general tend to be for and . There are of course some (relatively small) instances of Universities that allow you to get a dedicated or .
That, combined with a host of other factors, perhaps explains why so many wonder if there is a difference between finance and accounting at all.
And if there is a difference, what is it?
Let’s consider the first part of this.
Is there a difference between finance and accounting?
In a nutshell, yes there is.
But it hasn’t always been this way.
While they’re both ultimately derived from Economics, Finance and Accounting have gone down very different paths over the last few decades.
That being said, they’re both very much social sciences.
And anecdotal evidence is abound to show that the accountants – and accountants – are a lot more comfortable with this fact!
Reasons they’ve gone down very different paths include (but are certainly not limited to):
- A greater reliance on mathematical and economic theory / proofs in Finance vis-a-vis Accounting
- Different ‘core’ priorities – aiming for “global convergence” in Accounting vs. trying to explain the returns of all securities with one model in Finance (strictly, in Asset Pricing)
- Diverse technical talent (e.g. individuals from Physics and other ‘core science’ fields entering Finance, but not Accounting)
- Types, availability, and frequency of data – for instance quarterly data is usually the ‘most frequent’ data for Accounting, vs. high-frequency data (seconds or milli-second frequency) for Finance
Let’s now explore what the fundamental differences are.
What is the difference between finance and accounting?
Accounting is often called ‘the language of business’, and is responsible for communicating information about companies financial performance and financial position, broadly speaking.
Put simply, it exists to let you and I know about how much money a company has, how many “assets” (land, buildings, patents, software, etc) it owns, how much money it owes, and how much it is worth from the perspective of an accountant.
RELATED: What is the Accounting Equation?
Finance on the other hand focuses on using that accounting information and a whole host of other things so as to help individuals and companies:
- Allocate money efficiently, and invest it in the ‘right’ projects / firms (e.g., using capital budgeting techniques).
- Raise money from the ‘right’ source (e.g. borrowing vs. giving up a part of the business).
Both the examples above can be thought of as part of aspect of .
Another arm of Finance focuses on helping investors maximise their ‘risk-adjusted returns’ through a variety of tools including for instance, Investment Analysis and Portfolio Management.
We’ll dive deeper into the 2 arms of Finance in a bit.
For now, let’s consider another question you likely have – whether knowing one or the other is better.
Knowing one vs. the other
Die-hard finance fans might argue that accounting is irrelevant.
And accounting professionals of the same standing might contend that finance is immaterial.
Objectively though, it is hard to dispute the notion that a good finance professional knows financial statements inside out, and a good accountant knows the consequences of poor investing and financing decisions.
You don’t need to become a to realise that it’s foolish to invest all your money in one stock, for example.
And one doesn’t need to become a to know that one should stay clear of companies with a history of improper / fraudulent accounts / falsifying .
Ultimately, while Finance relies on Accounting information, the information communicated by Accounting is influenced by Finance, meaning there’s some sort of a cycle in operation.
So no matter how different these two fields might be, they need to live together to really work well.
To see what that means, and why it’s true, let’s split the subjects open.
Breaking down Finance and Accounting
Broadly speaking, Accounting can be split in to:
- Financial Accounting, and
- Management Accounting (aka )
Financial Accounting is the older of the two.
That’s where you’ll see the infamous and often dreaded “debits and credits” double entry system.
It’s also the accounting that most people see since it’s publicly available financial information.
By its very nature, Financial Accounting is very much ‘backward looking’ in that it relies on historic information for the most part.
Management Accounting on the other hand is internally focused, and exists for the management of firms.
It’s where you’ll see things like “Cost Volume Profit Analysis”, or “Investment Appraisal“, and other tools and techniques that attempt to look into the future.
Finance is usually split in to:
- Asset Pricing
- Corporate Finance
Asset Pricing is generally considered the “elegant” arm of Finance.
RELATED: Asset Pricing Models
It’s very much influenced by micro and macro economics, attempting to explain stock returns using seemingly simple models.
Corporate Finance is the messier half, mainly because it acknowledges all the twists and turns of the real world.
Interestingly, the influence of economics on Finance is very much explicit, unlike the implicit influence on Accounting.
One can see the economic influence in virtually every single model in Finance.
Most, if not all of them, rely on ‘perfect capital markets’, ‘frictionless trade’, ‘zero information asymmetry’, and other standard (albeit unrealistic) economic assumptions.
Where and how do Finance and Accounting meet?
It’s in Corporate Finance that we can literally see an overlap between Finance and Accounting.
The most trivial example of this can be seen in pretty much any Corporate Finance and Management Accounting course syllabus.
Both subjects will include a module on “Investment Appraisal” (aka “Capital Budgeting”).
RELATED: What is Capital Budgeting
Of course, when it comes to company valuation, one of the most popular techniques is the Discounted Cashflow (DCF) valuation.
The DCF valuation technique is heavily reliant on Accounting information in the form of financial statements.
In Advanced Financial Accounting / Analysis, one would look for answers to questions including:
- How do you measure the value of derivatives?
- How much interest should go on the Income Statement, given the effects of the “time value of money” for example?
- How do you get the “fair value” of an asset?
The answers to these questions inevitably come by applying theories and techniques grounded in Finance.
For example, if the Balance Sheet (aka Statement of Financial Position) of a company has bonds, the value of those bonds will be calculated using finance fundamentals.
While Asset Pricing proponents might argue that it is free from any need for Accounting, it only takes a glimpse into the Fama-French 3 Factor model to see how this is simply not true.
The model is one of the most cited and most popular asset pricing models, ever.
It has 3 components, one of which looks at the “value premium”.
The value premium’s evaluation of “high book-to-market” vs. “low book-to-market” firms needs accounting information right from the word go.
That’s not to say that all asset pricing models require accounting information, however. Perhaps the most notable – and famous – asset pricing model is the Capital Asset Pricing Model which doesn’t require any accounting information whatsoever.
The Key Takeaway
Finance and Accounting are both social sciences fundamentally derived from Economics.
And while they both heavily rely on each other, they’ve grown different over the last few decades.
They’re very different in their priorities and use cases.
For instance, Accounting exists to communicate information about businesses to stakeholders.
Finance however, exists to help shareholders earn a better return on their investment and to help firms make better “investing” and “financing” decisions that maximise firm value.
Ultimately, Finance and Accounting are interdependent, but different.