Introducing corporate finance
Introducing corporate finance

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Introducing corporate finance

Finance and accounting

Finance and accounting

In a typical large company, finance and accounting are functions within the same department. The finance director is responsible for both functions.

Play the audio below to hear two unit authors discussing the differences and possible conflicts.

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Transcript: Finance or accounting

Which is most useful when running a business – finance or accounting?

Janette Rutterford
Well, from my point of view finance is better because you look at the cash flows, you look forward and finance offers you a number of decision rules so that you can take investment decisions. You can decide whether to buy something, whether to invest in something. So basically with a finance framework you're home and dry.
Jane Hughes
But don’t you think accounting is essential for record keeping? I mean businesses need to keep track of where the money’s gone, how it’s been used. It’s all part of the stewardship role. I agree though that accounting is backward-looking.
Janette Rutterford
Yes exactly. Finance is forward-looking. It’s about the future, what’s going to happen. And it’s about cash flows, the real amount of money that you're going to spend.
Jane Hughes
I do agree that accounting is all about profits and we have difficulty with profits because of the nature of the way it’s presented and the way it’s calculated. It’s all to do with the fact that what you see in the published financial statements that profit figure is a mix of cash and non-cash transactions. An example of a non-cash transaction would be a sale on credit. So the transaction’s taken place but you haven't actually received the cash in. Because of those non-cash transactions – and it’s all to do with the accruals concept in accounting – but because of those non-cash transactions we have specific rules and guidelines about how to treat those items. That unfortunately has led to accountants having choice about what gets presented and how it gets presented and has really led to creative accounting because if you offer people a choice about how they can present their results, well it’s obvious isn't it? You’re going to choose the policy or the guideline which helps you show those figures in the best light, so you choose a way of showing it which is going to boost your profits. So that’s the difficulty with accounting. I do agree about that.
Janette Rutterford
Yes, but in the end, you know, there’s a problem in the organisation because you’ve got accountants talking about non-cash flow numbers and finance people talking about cash flows and they don’t always understand each other.
Jane Hughes
I'm afraid that’s true. There are different types of languages on both sides. We need to get them together and get them to understand each other’s language.
Janette Rutterford
And our students will be able to do that because they’ve already done some accounting and now they're going to do finance.
Jane Hughes
Exactly.

Which is better at adding value to the organisation?

Janette Rutterford
Well it must be finance because finance is about maximising shareholder value, adding value to the shares, making them go up over time, paying large dividends and all the rest of it. And the chief executive and the management of the organisation are supposed to act in a way which does that. And in fact they're incentivised to do so using shares and options on shares the idea being that chief executives will act in the interest of the shareholders if they too make money when the share price goes up. There's a problem with that though that sometimes, you know, they get rewarded the share prices of every company go up and they do very well. And another problem with options is that options do better the riskier the underlying investments. So sometimes management takes on risk unnecessarily just to make money out of their options. There's another way of doing it and that’s with accounting earnings.
Jane Hughes
Well, I think you’ve put forward some disadvantages of using options. Earnings – well yes it’s a good measure isn't it? You can use accounting profits. We use earnings per share as a standard key performance indicator but I would agree that you can manipulate profits and earnings so it may not be a very good measure of the success of that chief executive. Accounting though is a bit more about just calculating profits and showing that as a performance measure. We've also got this idea that accounting is about stewardship. And we can broaden that to think about safeguarding the assets, looking after the assets of the company for the range of stakeholders, the shareholders in particular, who own the company.
Janette Rutterford
Well, they haven't been very successful in doing that in some cases though have they?
Jane Hughes
No um we've got some good examples of when it hasn't worked. We've got Polly Peck, Maxwell Publishing from the 1970s, more recently Enron and Parmalat in the 2000s. What we've seen there is ultimately a failure in stewardship. The assets weren't safeguarded, which led to a loss of wealth, in some cases a loss of extreme wealth, for shareholders.
Janette Rutterford
And in fact part of the problem is that finance people are thinking of creative ideas and the accountants are always a bit behind catching up with the latest creative finance techniques and maybe that’s the way it’s always going to be.
Jane Hughes
Well it may be. I do think that you do need to have that record and monitoring going on because if you don’t know where you are how can you make decisions about where to go to? But I do think accounting tends to look backwards; tends to be reactive whereas finance is more forward looking, more proactive.
Janette Rutterford
So Jane – which do you think is better at adding value?
Jane Hughes
Well I think they both are. You need accounting. You need to know where you are and then you can be moving forward, looking forward. I have to say as an accountant I want to work with finance people who are proactive and thinking about developing the wealth of the organisation.
Janette Rutterford
Yes Jane. So you need the number crunchers and the creative finance types working together to maximise value for the organisation.

Would the world be better off without accountants?

Janette Rutterford
Well, quite a few people I know would say so. For example my son, who is having to struggle with book keeping at the moment, would certainly agree with that. He says ‘what's the point of accounting?’And there's a very famous accounting professor called Professor Anthony Hopwood, who used to say that some countries with lots of accountants did worse in GDP terms than countries with very few accountants. The argument being that instead of crunching the numbers they should be getting on with being innovative and entrepreneurial and inventing new products.
Jane Hughes
Well I've heard all those arguments before and I can quite understand them because I know many dull accountants. But the point about accounting is that it is very good at showing you the business and what it comprises. So for example, when you look on a balance sheet you can see the assets and how those assets have been financed. That’s really useful. That’s one of the key statements that goes out to stakeholders, shareholders in the annual report and accounts. So I think accounting is useful and certainly it plays a big part in business and you need accounting to understand business and to be able to communicate with finance and accounting people.
Janette Rutterford
And also to be able to compare companies one against the other for example. So I suppose I agree. And in a sense accounting is like a language and if you can't speak the language you can't challenge the numbers and it’s not about actually how the numbers came there it’s about understanding what the assumptions are, what they mean and whether they're actually reliable or not.
Jane Hughes
Exactly. So you need to be able to understand and communicate. So really knowing the accounting language, the jargon, is really important for all business managers.
Janette Rutterford
Even finance people.
Jane Hughes
And finance people.
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Finance or accounting
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Finance concerns decision making. Decision making is about the future.

Accounting is concerned with the recording of past events. In the annual report and accounts, the directors account to the shareholders for their past actions. Accounting takes an inward-looking perspective.

How are the activities of finance and accounting connected? Both are concerned with money!

The other connection is in business decision making. Decisions about the future rely on an analysis of past events. We look to the past for clues as to how future events might unfold. So one starting point – possibly the most important – of an analysis of a company’s future prospects, is an examination of its past record.

Finance and accounting perspectives

In summary:

  • finance takes an external and future perspective
  • accounting takes an internal and historic perspective.

The finance function

The finance function carries out two types of activities:

  • external, which tend to be treasury-related
  • internal, which tend to be accountancy-related.
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