Finance
and Accounting
The relationship
between finance and accounting,
conceptually speaking, has two dimensions: CO they are closely related to the
extent that accounting is an important input in financial decision
making;
and (ii) there. are key differences in viewpoints between them. .
Accounting
function is a necessary input into the finance function. That is, accounting is
a subfunction of finance. Accounting generates information/data relating to
operations/activities of the firm. The end-product of accounting constitutes
financial statements such as the balance sheet, the income statement (profit
and loss account) and the statement of changes in financial position/ sources
and uses of funds statement/cash flow statement. The information contained in
these statements and reports assists financial managers in assessing the past
performance and future directions of the firm and in meeting legal obligations,
such as payment of taxes and so on. Thus, accounting and finance are
functionally closely related. Moreover, the finance (treasurer) and accounting
(controller) activities are typically within the control of the
vice-president/director (finance)/Chief financial officer (CFO) as shown in
Fig. 1.2.
These
functions are closely related and generally overlap; indeed, financial
management and accounting are often not easily distinguishable. In small firms
the controller often carries out the finance function and in large firms many
accountants are intimately involved in various finance activities.
But
there are two key differences between finance and accounting. The first
difference relates to the treatment of funds, while the second relates to
decision making.
Treatment
of Funds The viewpoint of accounting relating to the funds of the
firm is different from that of finance. The measurement of funds (income and
expenses) in accounting is based on the accrual principle/system. For instance,
revenue is recognised at the point of sale and not when collected. Similarly,
expenses are recognised when they are incurred rather than when actually paid.
The accrual-based accounting data do not reflect fully the financial
circumstances of the firm. A firm may be quite profitable in the accounting
sense in that it has earned profit (sales less expenses) but it may not be able
to meet current obligations owing to shortage of liquidity. due to
uncollectable receivables, for instance. Such a firm will not survive
regardless of its levels of profits.
,The viewpoint of finance relating to
the treatment of funds is based on cashflows. The revenues are recognised only
when actually received in cash (Le. cash inflow) and expenses are recognised on
actual payment (Le. cash outflow). This is so because the financial manager is
concerned with maintaining solvency of the firm by providing the cashflows
necessary to satisfy its obligations and acquiring and financing the assets
needed to achieve the goals of the firm. Thus, cashflow-based returns help
financial managers avoid insolvency and achieve the desired financial goals.
To
illustrate, total sales of a trader during the year amounted to Rs 10,00,000
while the cost of sales was Rs 8,00,000. At the end of the year, it has yet to
collect Rs 8,00,000 from the customers. The accounting view and the financial
view of the firms performance during the year are given below.
Accounting
View
Financial View
(Income
Statement) (Cash Flow Statement)
Sales
Rs
10,00,000 Cash
inflow Rs 2,00,000
Less: Cost Rs 8,00,000 Less cash outflow Rs 8,00,000
_____________ ___________
Net
Profit
Rs 2,00,000 Net cash
outflow Rs 6,00,000
Obviously,
the firm is quite profitable in accounting sense, it is a financial failure in,
terms of actual cash flows resulting from uncollected receivables. Regardless
of its profits, the firm would not survive due to inadequate cash inflows to
meet its obligations.
Decision
Making Finance and accounting also differ in respect of their
purposes. The purpose of accounting is collection and presentation of financial
data. It provides consistently developed and easily interpreted data on the
past, present and future operations of the firm. The financial manager uses
such data for financial decision making. It does not mean that accountants never
make decisions or financial managers never collect data. But the
primary focus of the functions of accountants is on collection and presentation
of data while the financial manager's major responsibility relates to
financial planning, controlling and decision making. Thus, in a sense, finance
begins where accounting ends.
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