The Basics of Finance, Accounting, and Beyond

The Basics of Finance, Accounting, and Beyond

University of Phoenix

Americans constantly face the world of finance and accounting. Newspaper headlines, radio reports, evening television news-magazines, the internet, and even co-workers provide regular streams of information and opinions on money and the effect on the economy. There is always confusion as to what finance and accounting means exactly. Many people believe both these words have an identical definition. Some become frightened at the thought of the terms. The terms are easy to comprehend, once clearly defined, however. Although interrelated, finance and accounting mean different things. As a manager of any organization, one must realize the importance of knowing what the differences are.

Interestingly, the field of accounting has existed much longer than the field of finance. Accounting is "the process of identifying, measuring, and communication economic information about an organization for the purpose of making decisions and informed judgment" (Marshall, 2003). A key product of an accounting system is the set of financial statements. Providing financial data through income statements, balance sheets, and the statement of cash flow is the ultimate product from accounting information. The income statement provides detailed information of both the revenues and expenses for the organization while the balance sheet provides a cash balance at a given point in time. Then the statement of cash flow provides detailed accounts of how the company is spending its money. This practice also equates to cash activity.

Finance consists of three main interrelated areas. A money and capital market, which deals with macroeconomics topics, is the first area of finance. Money and capital markets include all institutions or organizations that are involved in the financial intermediation between savors (those who have surplus money) and borrowers (those who have deficit of funds). These markets include banks, insurance companies, stock markets, and brokerage and dealers firms, just to name a few.

Finance also focuses on the investment of individuals and organizations as they choose securities for their investment portfolios, personal or otherwise. The investments involve deciding where to make ventures from individuals or companies. There is the formation of providing an option of mixed securities or other investments. Stocks, bonds, or a combination of both within mutual funds is common within portfolios.

Managerial finance is yet another area of finance. This sect involves the actual management of an organization. Managerial finance also involves the process of analyzing the performance of an organization to make future decisions that will affect the performance of the company. The decision of an organization to merge with a competing company is an example of managerial finance. Although it is important to remember the future is not completely predictable, but rather involves solid decision-making and forecasting based on previous statistics and financial reports.

Accounting and financial information are important when making informed business decisions. The accounting information provides information about the past and future financial status of the organization. This information allows managers to understand what has worked for the company in the past as well as what needs to change. Finance information is important because it provides knowledge about viability of projects. Knowing whether a project is financially, economically, and socially viable can keep the company from losing money. The central goal of finance is the relationship of risk and return. Finance reminds investors of an organization that there are no "free lunches". Whatever decisions are made of the organization, there is a trade of one that has to occur in the terms of risk.

A financial statement that is used to asses an entity standing at any given point creates the balance sheet (Wikepedia, 2006). The balance sheet also is the only financial statement that applies to a single point in time instead of a certain period. The basic accounting formula for balance sheets is the relationship of the entities assets being equal to the liabilities and owner's equity (A=L+OE). Both sides of the equation must equal each other and therefore be in "balance". Assets include cash, inventory, machinery, accounts receivable, and so on. Some assets are difficult to measure from a monetary standpoint, such as trademarks. Liabilities can be loans, accounts payable, interest, etc. The owner's equity is the difference between assets and liabilities (OE=A-L), including cash brought in by the owner.

The creation of balance sheets does not have a specific interval but usually occur at the end of the fiscal year. However, a fiscal year does not necessarily start at the beginning of January and end on the last day of December. It is up to the company as to how the fiscal year will lay out. The differences between balance sheets of different points in time give rise to the income statement. Summarizing transactions such as revenues, expenses, gains and losses are included in the income statement.

Picture 1, as seen in the attached PowerPoint© presentation slide below, summarizes the relationship between the balance sheet and the income statement:

Consider plant A as being the snapshot of the assets of Vera Company one year ago. The assets are equal to the liabilities (pictured as spiny tips) of the company and the owner's equity (pictured by the girth of the plant). In a one-year period, the plant has grown and changed due to the conditions (transactions) that have occurred. The income statement will summarize these events and become the storyteller of why the balance sheet has changed within the time period demonstrated.

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