There is a misconception that accounting and finance are one in the same. We need to make a distinction in order to set the stage for this course. In Module 1 Course 1 – Basics of Accounting we discussed the processing of economic transactions. A set of principles is applied to help us post accounting transactions, currently referred to as Generally Accepted Accounting Principles. The main output from the accounting process is a set of financial statements.
Accounting tends to focus on short periods of time over and over again, generating financial statements to assess profitability. The goal is to maximize profits. Finance takes a longer term view of the business with an emphasis on maximizing value to owners. Yes, people who invest in companies are interested in profitability, but increasing the value of the business is also important since owners want a return on their investments.
Since finance looks at value over a longer period of time, finance will take into account risk and uncertainty as well as the timing and rates of return that are generated. Accounting tends to ignore risk and returns. What makes accounting more straight-forward compared to finance is that profits are relatively easy to calculate and analyze every month, quarter or year. However, trying to measure and analyze the value of a business is much more challenging and thus, finance may arrive at all kinds of answers whereas accounting tends to report a single answer.
This course will focus on finance (not accounting) – how investment decisions are made, how to allocate funds, and how to measure risk. This course also explains what it takes to increase the value of a business; i.e. maximize the wealth of shareholders or owners of the business. A few topics specific to finance will not be covered, such as analyzing financial statements. These topics are addressed in other courses. Specifically, we will attempt to answer the following questions:
Planning – How much money do we need to grow the business?
Investing – What is the best use of our funds to increase the value of the business?
Managing - How do we manage our short term resources?
Financing - How do we finance both our short term and long term assets?
Capital – What is the best mix and composition of capital?
“Finance is primarily concerned with value. The question ‘What is something worth?’ is asked again and again. The decision rule in finance says you should buy an asset if it is worth more than its costs.” – Corporate Financial Management by Douglas R. Emery, John D. Finnerty and John D. Stowe