Accounting versus Financial Management

A look at the differences between accounting and financial management:

Traditional accounting is not only inappropriate, but also misleading as a basis for making and monitoring organisational decisions. The increasing rate of change and wide-ranging sources of volatility affecting organisations demand a new type of accounting: financial management.

Reporting vs control

Accounting is, essentially, about reporting. How much profit has been realised in the form of tangible assets in a given period? The accounting model is used in a regulatory context, and the accounts are prepared or audited by passive and impartial observers.

Financial management, on the other hand, is about control - not about reporting on situations after the event. Financial managers are proactively involved in decision making and the shaping of events. The information they prepare is customised to the organisation's needs, in the context of its strategies.

Backward vs forward looking

Everything in the accounting model is, by definition, backward looking. The figures focus on what has already happened - quantifying how much of the wealth created has been realised in the form of tangible assets.

Financial management should be a completely forward-looking activity and thus reliant on subjective judgements about an uncertain future. The focus is on the creation of wealth, which implies future realisation, but until then, it is intangible. "If we invest in R and D, what increase in profit will we gain?" Nobody can truly answer that question.

Inward vs outward looking

Objective knowledge is a vital characteristic of accounting and auditing. Traditional accounting is, therefore, defined by an inward-looking focus on objective costs and capital maintenance.

Financial management is concerned with values and subjective judgements, and is largely outward looking. The question of whether or not capital is being maintained sits outside the realm of financial management. Instead, financial management asks: is adequate return expected to be created to warrant the employment of the capital?

Static vs dynamic

The accounting model is static, seeking to apportion transactions between discrete periods of time. It facilitates the calculation of profit for a period, weeks or months in arrears, and the assets at the end of that period.

Financial management is concerned with the dynamics of the business over the longer term. It can operate in real time. What matters is cash flow - specifically, the adequacy of the excess of inflows over outflows - relative to the capital employed.

This all emphasises the distinctiveness of the financial management model, which is designed to serve the needs of the people who make and monitor decisions.

Accounting and financial management tasks need to be clearly separated in organisational terms, and clearly communicated. If management wants the objectively verifiable truth about the past, they should ask the accountants. If they want help in making a judgement or strategic decision about an uncertain future, they should go to the financial manager.

As the pace of change increases in organisations, less time should be devoted to looking backwards. The past is not a reliable guide to the future. Many of us have difficulty embracing this, because of the inherent uncertainty. Financial managers need to be comfortable working with tolerances.

David Allen is an author for accountingcpd. To see his courses, click here.