Accounting is the language of business and it has many different dialects. Some people understand it extremely well and others understand it enough to get by. Fortunately, I love accounting and this allows me to help business owners effectively communicate their business to the IRS, other businesses, and banks. Most importantly, my understanding of accounting can help me advise and prepare analyses for business owners, illustrating how they can make more money.

The chart of accounts is an essential foundation to any business in understanding the financial health of the company. When a company installs a chart of accounts, it separates assets,  liabilities, equity, revenue, and expenses into different categories that allow for journal entries to be classified within the general ledger. Each account that is established will have its own name such as Marketing Expenses, Accounts Receivable, or Miscellaneous Expenses and may be accompanied by a number. The numbering system can help categorize accounts into each major class of account where asset numbering starts with 1, liabilities start with 2, equity start with 3, revenue starts with 4, and expenses start with 5. Though numbers are optional, they can significantly help with an understanding of journal entries and make the general ledger easier to review. For example, 101 Bank Account (****) is an asset, 201 Accounts Payable is a liability, and 520 Marketing Expenses is an expense account.

A chart of accounts is likely going to be different for every business due to every business having different transactions and wanting to group those transactions differently. The naming of the accounts is normally standardized across industries and within the accounting profession as a whole. Your chart of accounts should be easy to understand while also fitting normal operating activities of the business. Just as you do not want too many accounts (i.e. each vendor classified in a separate account), there also should not be a significant portion of your transactions classified under a vague heading such as 560 Miscellaneous Expenses.

What many believe to be purely a component of classification is actually one of the more powerful tools that accountants use to diagnose and analyze a company’s financial health. By preparing the Chart of Accounts properly, you can identify things you want to track and easily separate the items when referring back to any time period through a financial statement based on that time period. For example, if I owned a building, office equipment, and a couple of vehicles, I could classify these all into one account being Property, Plant, and Equipment which is acceptable on the Balance Sheet. I could also classify these into 3 different accounts, Building, Office Equipment, and Vehicles which would allow me to better understand how invested I am into each of these categories.

More complicated situations can exist where you may have many large product lines which are held under one company but are completely separable. Numbering can dramatically help separate these activities within your operations. Instead of revenues from both lines starting with (4***), you could account Line 1 with (41**) and Line 2 with (42**). This will allow your income and expenses to be easily distinguishable while also keeping the financial statements easy to prepare and consolidate the 2 product lines.

For my business, I track marketing expenditures in additional detailed accounts. Website expenses, business cards, social media advertising, t-shirts, etc. should all be classified under Marketing Expenses in most situations. For myself, I have social media expenses accounted for separately from other marketing expenses. I like to keep a closer eye on how much I am spending on social media which has little residual value compared to other marketing (i.e. business cards and t-shirts). This separation also allows me to calculate ratios quickly as I plan to spend a percentage of revenue on social media. Preparing my chart of accounts in this way allows me to prepare financial statements in future periods and to review social media expenditures over time more easily. I also distinguish between various revenue activities. For example, some revenue accounts are: accounting services, website services, and I leave the opportunity to account for other service classes so that I can understand what revenue types are making me the most revenue.

It is important to plan this chart of accounts on the front end of your business journey. Though you can change your chart of accounts at any time, making a change reduces the ability to compare time periods which makes it difficult to perform long-term analysis. In my time as an auditor, making changes to the chart of accounts was not only painful for the client but also for the people preparing the financial statements. It is best to consult with your accountant when creating your chart of accounts as many accountants will have a knowledge base of best practices you can follow. A high quality accountant will be able to guide you through build-out along with identifying things which you might not think about that are trackable.

Hopefully this was a helpful dialogue to help you make better decisions when building the chart of accounts you want to use for your company. As always, feel free to reach out if you have any questions or would like to discuss your bookkeeping needs.