Opening up a chart of accounts is imperative if you want to improve your company’s financial reporting. But it is one of those key accounting functions that is overlooked all too often. Without a well-structured chart of accounts, your invoice lines will flow to a single sales account, leaving you unable to decipher the specific details of your distinct revenue streams.
Think of the chart of accounts as a storage system – not unlike a traditional warehouse – only in a digital format. Just as a warehouse would route specific items to designated shelves or sections, making it easier to retrieve stock when it is ordered, a chart of accounts compartmentalizes your revenue streams. In a warehouse, without a well-organized storage system, retrieving goods is a logistical nightmare. And like a good storage system, an effective chart of accounts is flexible, and adapting to the changes that occur as your business evolves. It ensures consistent detail when viewing financial data.
Structuring the chart of accounts
Businesses often structure charts of accounts in ways that are far more complicated than necessary or not as effective as they could be. Most accounting software builds a pre-determined chart of accounts, as many companies struggle to set one up themselves. Unfortunately, a one-size-fits-all approach is not very functional.
When structuring a chart of accounts, you need to consider three things:
- The number of accounts
- The definition of what goes onto each “shelf”
- The organization of the “shelves”
Each of the accounts in the chart of accounts will feature in two financial statements – the balance sheet and income statement.
The Balance Sheet:
- Asset accounts, which include anything you own that has value
- Liability accounts which include things like bank loans, mortgages, income taxes payable, and your bills
- Equity accounts, which reflect owner contributions to the business, as well as shares of ownership
- Revenue, which is the income that the business makes through the sale of products or services
- Expense accounts, which represent any money that you’ve spent
How to list your accounts
How you list your accounts will depend on the nature of the business. For example, a restaurant will include accounts that are specific to their business such as meat suppliers. They will also have general accounts that are common to many businesses, such as inventory.
Use a numbering system for easy identification and transactional recording. A three-digit numbers system is common for small businesses, while large businesses use four-digit numbers to allow room for growth.
In a manner reminiscent of the Dewy Decimal System, groups of numbers are assigned the five main categories and blank numbers are left at the end, allowing for the addition of accounts when necessary. A consistent, clear numbering system will ensure management can access the information easily.
Example: A large business numbering system
- Assets: 1000-1999
- Liabilities: 2000-2999
- Shareholder’s equity: 3000-3999
- Expenses: 4000-4999
- Revenue: 5000-5999
A good tip to follow is to avoid creating a new line item for each transaction. It could clutter your company’s chart, making it difficult to navigate.
Make use of your sub-accounts. For example, should you need to create a new account for “PayPal fees”, create a sub-account under “Bank fees.” If you are leasing a building or equipment, you might set up a “Lease” account with sub-accounts for “Building lease” and “Equipment lease.”
Benefits of a well-organized chart of accounts
A well-organized chart of accounts gives a clear picture of your company’s financial health, allowing you to plan for the future. Your chart of accounts can keep track of where all the money in your business is coming from. It also allows you to get an overview of all the money your business owes, as well as all the money going out of your business.
You can see your recurring payments, which helps you make better spending decisions – you see where your money goes and can evaluate where cuts can be made. A well-organized chart of accounts makes tax season much more efficient too.
Your chart of accounts helps look toward the future, by understanding your past and keeping your business accounting on the straight and narrow.
For a more detailed, professional overview of charts of accounts, get in touch with the Strata-G team. We offer full-service virtual accounting services from corporate tax to bookkeeping, tax consulting to startup accounting, accounting software management and more. Send us a message online and we’ll help you figure out the best strategy with our next level accounting services.