Finance vs Accounting: An Art and a Science
Accounting and finance are often incorrectly used as interchangeable terms. While accounting is more of a science, finance is more of an art. There’s nuance in how each field approaches calculations.
There are four main differences between accounting and finance:
- Accounting looks at what’s already happened, while finance focuses on the future.
- Accounting is reporting, finance is estimating.
- Accounting documents “non-cash items” and finance documents “cash items.”
- Accounting professionals study numbers and finance professionals study business.
Last Updated January 2021
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Let’s take a look at these distinctions.
Are you looking backward or forward?
Accounting is historical. It deals with documenting what’s already happened. When we file taxes, we are accounting for what’s taken place over the past year. Finance looks at the future — it is about forecasting what will happen. Finance also deals with estimating how much money we think we are going to make.
Accountants analyze how much money a company or a person has already made. Finance professionals predict how much money a company might make in the future. Financial professionals must be comfortable with uncertainty. They must also be comfortable with managing risk. Forecasts made by financial professionals will never be 100% accurate. Accountants must be 100% correct when they document historical financial statements.
Are you reporting or estimating?
Accounting is a science because it is exact. Accountants must be completely accurate when they document financial statements. Finance is more of an art. You are forecasting what you think will happen. When forecasting, you are estimating what will take place. You need to be comfortable with uncertainty when you’re forecasting. Unlike accountants, you’ll never be able to be entirely sure of an outcome.
Of course, that doesn’t mean you have to make it up as you go. Finance professionals use several methods to pick a target price. A target price is a prediction of what a company will be worth in the future. Many finance professionals value companies using the discounted cash flow (DCF) valuation method. They may also use the price to earnings (P/E) and price to revenue (P/R) methods. Using more than one method reduces the margin of error if one valuation approach ends up being wrong.
So how do those methods help you estimate? DCF values a company by forecasting how much cash a company will make in the future. DCF uses three financial statements and focuses on the cash flow statement. P/E values a company by forecasting a company’s future earnings, using the income statement. P/R values a company by forecasting a company’s revenue and using the income statement. P/R is especially useful if a company is not yet profitable, but you want to estimate what might happen once it is.
Are you looking at cash or non-cash?
We usually think of money matters in terms of cash. Whether we are reporting or estimating, we are thinking of cash, right? Not exactly. Accounting and finance professionals both depend on these three financial statements:
- Income statement
- Cash flow statement
- Balance sheet
But, accountants and finance professionals use these three financial statements in different ways. Finance professionals use the cash items version of the financial statements. They do this because it makes it easier for them to forecast what companies will be worth in the future.
Accountants also deal with what we call “non-cash items.” So what is a non-cash item? One example is depreciation. Depreciation is when you buy an item, like a machine. You can account for depreciation expenses over the useful life of that machine.
When accountants file taxes, they send governments the three historical reports. An accountant often creates two sets of these three financial statements. One set has only cash items, and another set has non-cash items.
The income statement tells you how much money you make minus how much money you spend. Accountants include non-cash items on income statements, including depreciation. Finance professionals often exclude non-cash items from income statements. Many finance professionals think that the income statement is a lie because it has many non-cash items. This is why the cash flow statement exists.
The cash flow statement “corrects” the income statement. It explains exactly how much more cash you will get at the end of an accounting period, like a quarter or a year. This is important because a company is worth as much cash as it makes in the future. Finance professionals forecast future cash flows. They use the forecasted cash flows to value companies.
The balance sheet documents what you have (assets) and tells you who owns what you have (liabilities and equity). Liabilities include items like debt. Equity deals with who owns your assets. Let’s say you have a car that costs $10,000. You paid $4,000 in cash for the car and you got the Bank of Toyota to give you a $6,000 loan. Think of the balance sheet as a set of balance scales. On the left side of the scale is assets (the $10,000 car). On the right side is liabilities (the $6,000 loan from the Bank of Toyota). Also, on the right side is your ownership in the car (meaning your “equity” of $4,000). Assets = Liabilities + Equity.
What do you want to study?
Large companies hire accounting professionals. Most accountants need a degree in accounting as well as a certification. They need to have a solid understanding of financial reporting and are trained in looking at the numbers.
Accountants are often experts in the field of management accounting and financial transactions. Many have experience as auditors at audit firms, including Deloitte, KPMG, and PwC.
Large companies also hire financial professionals, and usually at least one financial analyst. They often work in the company’s corporate finance department. Financial professionals often study finance in college and go for advanced degrees like an MBA. They are highly trained in business.
Financial professionals have a solid understanding of financial management and financial information. They are experts at analyzing financial records. Even government organizations like the Bureau of Labor Statistics hire financial analysts.
The bottom line is that accounting is an exact science, looking at everything that came before. Finance is an art, looking at what came before to estimate what will come next. Both call for a study of finance. Accountants will focus on learning exact numbers and rules, and the finance professionals learn about business and prediction.
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