When we talk about business, the first thing that comes into our mind is money. Generally, that is the means and ends of for-profit entities- to keep earning money. To be able to do this, having the knowledge about accountability and management of money becomes a necessity to every businessman.
Businessmen must know how money revolves around his business, how to generate money, where money came up from, how money is spent, and how to make use of the money. Basically, every businessman must know the past, present, and future of his business, in financial terms.
Many businessmen claim that they understand accounting software and finance enough for them to start out their business ventures. Yes, accounting and finance are the basics of business, to which an entrepreneur should be conversant of. And being the founding tools of business, it is very important that every businessperson should be well aware of the functions and uses of accounting and finance. Thus, let us solidify your knowledge about Accounting and Finance.
Definition of Accounting and Finance
A common misnomer is the idea that accounting and finance are the same thing. But in reality, accounting and finance are two separate process, in business. They are two different aspects of business that harmoniously work to keep the business going. Yes, they are very much related, in a symbiotic relationship, but they are not the same.
Accounting, as defined by the American Institute of Certified Public Accountants (AICPA), is “the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character, and interpreting the results thereof”.
It is the whole process which will answer the what, where and how of the business in terms of money.
The underlying concept about accounting is that it is the reporting about the status of the business using the financial language which is money. Accounting begins with the process of identifying which events and transactions affect the financial standing of the business.
Normally, a business undergoes a lot of dealings and happenings every day, but not all of these occurrences qualify to be recognized as an accounting event. Only accounting events are recorded and included in the accounting process.
For example, Company ABC is a dealer of beauty products; it purchases items for resale from a supplier, stores these items into their warehouse, and ultimately place them into their stores for selling to customers. The process where Company ABC fill their warehouse with beauty products bought from the supplier qualifies as an accounting event because the company disbursed cash to the supplier in exchange for the products.Thus, it affected the company financially and must be recorded.
On the other hand, the act where the company moved some of the items from their warehouse to their store does not qualify to be an accounting event because the movement did not affect the company financially. The movement of the merchandise did not change the fact that the items are still for resale and were not converted to cash or any form but remained as part of the inventory. The basic rule, in classifying whether the transaction should be recorded or not, rely mainly on recognizing if the event affects the business financially or not.
During recording, events are further classified as to which part of the accounting information it belongs, the classifications are listed below:
- Assets – events which give rise to resources that will benefit the company;
- Liabilities – events which give rise to monetary obligations;
- Income – events which give rise to earnings for the company; and
- Expenses – events which give rise to outlays or charges against the earnings of the company.
At an interval, or what is called “at the end of the accounting period”, the accounting events, which are recorded at their monetary value, are then summarized according to their classification.
This significant summary of accounting information is called Financial Statements. Financial Statements presents the financial standing of the company. It shows what the company did with the money, was the company successful in making use of the money, and the rest of the company’s history and status of the finances of the business.
The interpretation of these financial statements is what correlates accounting and finance. Financial Statements is the intermediary link between Accounting and Finance.
Finance is a lot broader concept compared to accounting. It encompasses accounting, economics, taxation, business laws and all other fields contributory to the whole process of acquiring and utilizing funds for the benefit of the business.
Bonneville and Dewey (1945) defined the finance function as consisting of “raising, providing, managing of all the money, capital or funds of any kind to be used in connection with the business”.
Information from the financial statements are used in the finance function in meeting investment opportunities available to optimize earnings. The finance function is composed mainly of two features: (1) Profitable Investment Opportunities; and (2) Optimal Mix of Resources.
Profitable Investment Opportunities
Profitable investment opportunities are occasions that a business may encounter or make in its everyday dealings wherein involvement bring income to the company. And, involvement always requires the company to put money. A keen eye for profitable investment opportunities should be mastered by a good businessman. Opportunities come and go, but not all opportunities are profitable, and give the company more than its money’s worth.
Optimal Mix of Resources
As mentioned, investment opportunities always require the business to put money. Sources may include funds from the business itself, raised capital from owner/s, and borrowed funds from third parties such as banks, financial institutions, and government. Your company should use the best possible combination of these sources to maximize the profits from these investment opportunities.
The finance function makes sure the balance between the funds acquired from these sources against their costs. Information is gathered from the company’s own financial statements and quotations from third parties for possible funding.
Finance decisions always result to accounting events. The outcome is always recorded, and thus, form part of the accounting process because they affect the financial status of the company.
That’s why it is very important for every businessman to have the knowledge about accounting and finance and the relationship between the two.
Accounting information is the foundation of the finance function. The results of finance function decisions are accounting data ultimately processed into accounting information. And the cycle goes on. Yes, it is definitely a cycle. A cycle, which when turned in the right way, will definitely give your business the earnings it is worth.
Bonneville, Dewey. Organizing and Financing Business. Prentice Hall; Third Revised Edition (1945).