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Monday, April 22, 2024

What’s the Difference between Finance, Accounting, and Economics?

Understanding the distinctions between these three fields is an important first step to learning what they are all about.

Image Credit: Sam Valadi - Flickr | CC BY 2.0

Whenever I meet someone, at some point, the subject of what I do for a living comes up. When I tell the person that I work in economics education, they often seem to have misconceptions about what that entails. They’ll ask me for investment advice or economic forecasts.

“Oh, you work in economics? What stocks would you recommend? What do you think will be the next big business trend? Where do you think interest rates are heading?”

These questions are perfectly innocent, but they betray a somewhat serious ignorance on the part of the person asking. More specifically, they indicate that the person doesn’t understand the distinction between the field of economics and the field of finance.

Another common misstep has to do with the field of accounting. Is it just another word for finance, or is it something else entirely?

To avoid being the kind of person who asks the wrong questions to the wrong people, it’s helpful to get an understanding of what these three fields are all about, and what they aren’t about. To that end, let’s take a look at each one in turn.

Finance

The Merriam-Webster dictionary defines finance as “the science or study of the management of funds.” It defines the financial system as “the system that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities.”

In brief, the field of finance is all about how money is used, both in the economy and in our personal lives. This means it tries to understand things like purchases, loans, investments, and acts of saving.

Between finance, accounting, and economics, finance is the one that is probably most closely associated with the business world and the stock market. Keep in mind that stocks and bonds are called financial instruments, and it is financing that is always top of mind for business leaders.

So what is finance not about? Well, one thing it’s not about is keeping records of financial transactions. That falls under the domain of accounting.

Accounting

Merriam-Webster defines accounting as “the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results.”

An accountant is someone who “takes account” of what has happened. They meticulously track the inflows and outflows of money for a business or individual, and prepare financial records such as balance sheets and income statements.

To study accounting is to study the various ways that financial information can be recorded and aggregated. There are a variety of standards that have been developed over the years which accountants follow, allowing financial statements to be easily reviewed by anyone familiar with the generally accepted methods of preparing them.

Accountants are the ones who calculate the profit margin of a company, and they also calculate a host of related statistics that help business leaders assess the health of their organization.

As the economist Ludwig von Mises wrote in his 1927 book Liberalism:

In the calculation of profits and losses, which constitutes the whole sum and substance of the businessman’s bookkeeping and accounting, entrepreneurs and capitalists possess a method that enables them to check, with the greatest attainable exactitude, every step in their procedure down to the smallest detail and, where possible, to see what effect each individual transaction in the conduct of their operations will have on the total outcome of the enterprise. Monetary calculation and cost accounting constitute the most important intellectual tool of the capitalist entrepreneur, and it was no one less than Goethe who pronounced the system of double-entry bookkeeping “one of the finest inventions of the human mind.”

One of the things accounting is not about is looking to the future. An accountant is concerned about accurately capturing what has happened in the past and turning that into useful information. It is the entrepreneur’s job to figure out what to do with that information going forward.

Economics

Economics, according to Merriam-Webster, is “a social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services.”

This definition isn’t terrible, but many would argue that a better definition would reference the study of scarcity or the study of human choices. As Mises wrote in his 1949 economic treatise Human Action, “Economics is not about goods and services; it is about human choice and action.”

Putting aside the matter of definition, economics can be broadly described as a social science that tries to understand the various “economic” phenomena we experience in society. It asks questions like “What factors influence the movements of prices?” “Why do firms form and what determines their size?” and “What is the function of money in an economy?”

As you can hopefully see from these questions, economics is far more philosophical than accounting or finance. It’s trying to understand the mechanisms that push and pull the economy in different directions—the design of the whole system, if you will.

Because of this distinct focus, economics is very much not finance or accounting, and expertise in economics does not automatically imply expertise in these other fields. Though economics certainly tries to understand the world of businesses, stock markets, and financial transactions, it cares much more about the system-level theory—how do profits and losses influence resource allocation?—rather than technical matters—how do different financial instruments help to generate profits?—or matters of record keeping—what’s the best way to measure profitability?

A Word of Caution

Now that you are armed with the knowledge of these distinctions, it can be tempting to think you are ready to start weighing in on debates about these subjects. But this is a temptation that is important to resist. Certainly, by learning these distinctions, you’ve taken an important step toward mastery, but there is still a lot to learn, so some intellectual humility is called for.

The economist Murray Rothbard had this to say about his own field:

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a “dismal science.” But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

The same undoubtedly goes for accounting and finance. So the next time you find yourself in a discussion on these topics, try to take the attitude of a student rather than a partisan. By spending time learning and asking questions, you can slowly develop your knowledge and understanding. And if you keep at it long enough, perhaps one day you will be the one shaking your head at the people who hear the word “economics” and immediately think about the stock market.


  • Patrick Carroll is the Managing Editor at the Foundation for Economic Education.