Accounting And Finance

Accounting and Finance

If you ask those in the industry for a specific definition of "accounting" or "finance," you would probably get several different answers. In simple form, accounting involves the accumulation of historical information. Webster's dictionary defines it as "the occupation of maintaining and auditing records and preparing financial reports for a business. Finance, on the other hand, involves analyzing the historical information and using it to plan and make future decisions. This includes such areas as budgeting, forecasting, strategic planning and due diligence.

Distinguishing Between Accounting and Finance

Accounting is the language of business. It is used to communicate financial information about an organization. Accountants are trained to critically evaluate alternatives. They examine which approach will be best for a business when more than one approach can be logically supported. Accounting is also the process of identifying, measuring, and communicating economic information about an organization for the purpose of making decisions and informed judgments. Users of accounting information include the management of the entity or organization, the owners of the organization, potential investors and creditors of the organization, employees, and various federal, state, and local governmental agencies that are concerned with regulatory tax matters.

The central goal of finance is the relationship of risk and return. Finance is generally concerned with how individual and business organizations raise money and capital, and how those resources are allocated among competing investments and spending opportunities. At the individual level, making financial decisions involves planning for and borrowing to meet everyday living expenses and to accomplish long-term goals such as buying a home, college education, retirement, and financial security. At the organizational level, financial decision involves the evaluation of alternative business opportunities and investments which translate to the potential contributions to the organizations.

Informed Business Decision-Making

"To ensure an environment of accountability and well-informed decision making, you need a system that collects and links as much information as possible" (Webb, 2005). Decision makers of all types and organizations will benefit greatly from achieving a basic understanding of accounting. Accounting and financial information is used in all types of business, from small to large. Many books and online articles claim managers, decision makers, and stakeholders in these organizations do not need to know detailed information such as journal entries, balancing balance sheets, and the like, they just need to be able comprehend the basic accounting concepts and how to use the information presented to make informed decisions. Marshall, McManus, and Viele (2003) stated, "Decision makers cannot truly comprehend financial statement data without understanding the concepts and principles that relate to the entire financial accounting process. It is also important for users to understand that these concepts and principles are broad in nature".

Balance Sheet and Income Statement Relationship

Financial statements are used to report economic information about a company. The four standard financial statements include: the Balance Sheet, Income Statement, Statement of Changes in Owner's Equity, and Statement of Cash Flows. Each financial statement has its own unique reporting function, but relationships do exist between various statements, such as the Balance Sheet and Income Statement.

The Balance Sheet is used to report an entity's assets, liabilities, and owners' equity at a given point in time. The Balance Sheet is broken into two sections presented side-by-side and each side will have the same total amount, hence the name balance sheet. The asset section summarizes the company's resources that are owned, such as cash, merchandise inventory, accounts receivable, and equipment. The other section summarizes the company's total liabilities and owners' equity. Liabilities are financial obligations owed to others, such as accounts payable, short-term debt, and long-term debt. Owners' equity is the amount of ownership they have in the company's assets after deducting all the liabilities. The Balance Sheet can be prepared on any date, but is most often prepared at the end of a company's fiscal year.

The purpose of the Income Statement is to report if the company operated at a profit or loss for a given period of time. The statement begins by reporting the amount of net sales that was made from selling goods or services. The number of expenses incurred from generating the sales is subtracted from the net sales amount giving a net income or net loss. The amounts on the Income Statement represent a summary of transactions that took place over a given period of time. These transactions either increase or decrease the net income of the company. All income statement transactions will also affect the Balance Sheet, thus creating a relationship between the two financial statements.

Another relationship between the Balance Sheet and Income Statement is owners' equity. The net income from the Income Statement represents a profit (or loss) and is a component used in calculating owners' equity which is shown on the Balance Sheet. The net income is added to the beginning retained earnings amount and dividend amounts are subtracted giving the ending retained earnings amount. The ending retained earnings amount is added to the paid-in capital from sale of stock giving