What would you do if your company was asked to retrieve the specific dollar amount from an invoice that was issued over a year ago? You might panic for a second, then dive into a big pile of paperwork. You might have to spend hours sifting through months’ worth of invoices to find the exact number. Worst case scenario, you run into a roadblock when you realize you weren’t very organized with your filing system. Some documents might even be missing.
In other words, it could be a very hectic ordeal. Unless you used a chart of accounts, that is. A chart of accounts allows you to allocate every transaction from your business to a category. That way, you can see exactly where your business is making and spending money. This can be everything from a new bank loan, an invoice from a client, or a receipt for a new office computer.
No matter what type of business you operate, you need a chart of accounts. In this post, we’re breaking down everything you need to know about a chart of accounts and how your business can successfully use one.
So, What is A Chart Of Accounts?
The chart of accounts (COA) is a financial organizational tool that acts as a complete list of every account being run by a business. How are we defining an account? It’s a record for each type of asset, liability, equity, revenue, and expense. The COA sorts, organizes, and consolidates each of these accounts where applicable, making things easier for tracking and logging.
Put simply, a COA is meant to replace a more old-school system: setting up separately labeled drawers for all your important accounting paperwork. But instead hundreds of papers, it gives you a high-level view of every area of your business that spends or makes money by listing all the accounts involved in your day-to-day operations. For instance, you’ll want to include details such as any sales, the rent for your office space or storefront, cost of shipping product to customers, etc.
If your business utilizes an accounting system, like ScaleFactor or QuickBooks, you already have a chart of accounts and don’t need to build one outside of your chosen online system. Rather, you’ll just need to refine the categories transactions belong in.
Why Is It Important to Have a Chart of Accounts?
The goal of a good COA is to categorize information in the clearest and most informative manner. The better the organization of the COA, the more information that can be gleaned from the COA itself. Since the COA feeds your financial statements, the biggest benefit to an organized COA is accurate, useful reporting.
The financial insights from such reporting are what enables businesses to determine reasonable growth plans, know when it’s time to seek additional investments, and gain a more holistic view of how to business is performing overall.
How Do I Use a Chart of Accounts?
Every time you take note of a business transaction—from invoices to office purchases—you should record it in your COA. But how do you know which account to record it in? In general, there are different financial statements that each account corresponds to: the balance sheet and the income statement.
A balance sheet shows the big picture of your business. By knowing what a company owns (assets), what it owes (liabilities) and what is left over for the company owners after paying off any financial obligations (owner’s equity), you can get a snapshot of exactly where your business is at a specific point in time.
Your balance sheet accounts would include:
Asset accounts record any resource your company owns that provides value. This includes: inventory, real estate, equipment, and accounts receivable.
Liability shows all the debt your company owes. This includes: accounts payable, taxes payable, and wages payable.
Equity measures how valuable a company is to outside shareholders. It’s essentially what’s left when you subtract a company’s liabilities from its assets. This includes: common stock, preferred stock, and retained earnings.
Your income statement shows you what kind of money you have to work with. There are two types of accounts here:
- Revenue Accounts: These accounts are a reflection of the revenue your business brings in from sales.
- Expense Accounts: These accounts reflect all the money and resources your business uses to generate revenue.
Chart of Accounts Example
|Accounts Receivable||Current Asset|
|Office Equipment||Fixed Asset|
|Computer Equipment||Fixed Asset|
|Accounts Payable||Current Liability|
|Wages Payable||Current Liability|
|Meals & Entertainment||Expenses|
What Are Some COA Best Practices?
To help you best manage your COA, here are some things to keep in mind:
Wait to Delete Old Accounts
To make sure you don’t mess up your books, it’s best to wait until the end of the year to delete old, inactive accounts. It’s also wise to avoid merging or renaming accounts (which can create headaches come tax season). Fortunately, you can easily add new accounts whenever you want.
Pro tip: Avoid making any accounts that will only be used for a certain period of time (i.e. “Company events” is better than “Christmas party”).
Don’t Get Carried Away With Accounts
Creating a COA is important to get a birds-eye view of your business, but that doesn’t mean every single detail from every transaction needs to be in there. For example, you don’t need a separate account for every product you sell or your different utilities. You will rarely need more than 50 accounts, and never more than 100. Consider combining line items with similarities to keep things tidy and easy to read.
But Don’t Be Too Generic
Sometimes it’s easy to not provide enough information. All account names should have a clear title so everyone in the accounting department understands what each account is for, which helps to easily and correctly classify company transactions.
On the other hand, account names should never be tied to a specific vendor or customer (i.e. “Software subscriptions” is better than “Salesforce subscription”).
Try To Be Consistent
A COA that doesn’t fluctuate from year to year is the ultimate goal. This gives you valuable insight into how you are managing your business’s finances.
Leverage Accounting Software to Easily Track Financial Transactions
A well-designed COA should make it easy to quickly see where your company’s finances are going and how it’s doing year after year. Request a demo with ScaleFactor today to learn how its software can help you keep track of your accounts without all the annoying paperwork.