How to Rein in Your Chart of Accounts
The chart of accounts (COA) is one of the company’s most fundamental accounting tools. It is a core resource that is essential to the very heartbeat of your business because it creates the financial framework for the accounting transactions, which ultimately drive financial statements and reporting.
Every company utilizes this critical tool to organize how accounting activity is recorded, and ultimately reported, both internally and externally.
To be effective, a chart of accounts should be fluid and scalable, yet logical so that is can grow in sync with the lifecycle of the business. When set up correctly, internal staff should be able to look at it and quickly locate the desired account associated with certain business activity. External users should be able to read a financial statement that clearly presents the company’s financial information in a logical and meaningful format, based on the chart of accounts structure.
However, it is very easy for the chart of accounts to spiral out of control. This will lead to inefficiencies, errors, maintenance challenges and potentially, increased audit costs. In fact, almost universally, troubled companies have a poorly structured chart of accounts that inhibits good financial management.
Producing effective and meaningful financial information is the ultimate goal of any accounting system, and the chart of accounts is the account listing that drives that information. An effective chart of accounts will allow for enough flexibility, balanced with sufficient detail to easily produce financial statements that are meaningful to a wide variety of audiences.
With thoughtful planning and insight into the business model and direction of the business, setting up a chart of accounts from ground zero can be done effectively. However, many business leaders spend little if any time considering how to create or optimize this tool in a way that will serve their organization. This narrow approach misses a valuable opportunity to help you use your chart of accounts as a strategic tool in managing your business.
With that in mind, here are some key ways to develop and optimize your chart of accounts today:
1. THOUGHTFUL PLANNING
Ultimately, the chart of accounts creates the structure of the financial statements which are intended to “tell the story” of the business. Make sure that it aligns with the financial model to make the marrying of historical information to forecasted information as seamless as possible.
The chart of accounts should have a meaningful and logical structure, which will show the company’s growth and its overall health in clean and concise reporting. When structured effectively, financial statements can be created at multiple levels and allow executive teams to quickly communicate financial information as high-level or as detailed as required. It should be organized in a matter that allows for revenue and cost segregation by lines of businesses or products. This is invaluable when a company looks to investors for financial support as well as guidance in the growth of a company. For example, when a company’s executive team goes out looking to raise a Series round, a thoughtful chart of accounts eases the process of developing a robust forecast model.
The core structure of a chart of accounts is to address five categories essential to the accounting cycle. These include:
- Assets – tracks what the company owns
- Liabilities – tracks what the company owes today or may owe in the future
- Equity – tracks your investment in the business
- Revenues – tracks your company’s sales revenues, cost of goods sold and investment or other income
- Expenses – tracks your company’s expenses
From this basic structure, a chart of accounts can be designed in more detail to create the various accounts needed in each category. Depending on your accounting system’s functionality, it’s important to remember to utilize departments and subaccounts. This will allow for activity to be “sliced and diced” in multiple ways without the need for creating an infinite number of accounts.
3. REVIEW REGULARLY
As your business evolves and grows, review your chart of accounts annually to ensure that it continues to align with the business model. If it makes sense to break out new lines of business, or close out inactive accounts, do so to avoid accounting errors in the future.
Here are some common mistakes you should avoid:
- Not planning for growth
When you set up your chart of accounts, think of the future. Go ahead and start with the accounts that are needed right now, but also set up the structure to support your businesses growth 5 or 10 years down the line. And be prepared to add accounts as your business changes.
To solve that problem, many small business CPAs advise their clients to use a numbering system organized around the following account categories:
- Assets – Account numbers 1,000 to 1,999
- Liabilities – Account numbers 2,000 to 2,999
- Equity – Account numbers 3,000 to 3,999
- Revenues – Account numbers 4,000 to 4,999
- Expenses – Account numbers 5,000 to 5,999
This will make it meaningful for all users and gives you adequate space in the numbering schema to add new accounts in the future as your business changes and evolves.
- Overlooking how your leadership and stakeholders want to analyze business activity
Will there be a desire for departmental reporting? Thinking through how the company wants to report any department activity will guide in how this important tool is set up. If departments/classes can be utilized within the accounting system, then the chart of accounts does not need to get out of control in trying to have 3-5 travel accounts, one for each department. Map out the company structure first, before sitting down to set up a chart of accounts.
- GL account names not being meaningful
The account names should be self-explanatory. For instance, an internal user should be able to look at the chart of accounts and know quickly (in most cases) where to code an expense item.
- Being concerned your chart of accounts is not perfect
This tool is fluid, not stagnate, and can always be updated. No chart of accounts is ever perfect the first go around. There may be account names that will be changed or accounts that need to be added shortly after its creation. Remember: Your chart of accounts is ever-evolving just as your business is!
BRINGING IT ALL TOGETHER
In the end, an effective chart of accounts is a financial framework that serves as your map of the past, present and future. It’s best to keep it simple, logical, and aligned with the financial story of the business. With a clearly structured organized chart of accounts, you’ll have a better understanding of your accounting and a stronger ability to make the right decisions for your business now and in the future.
If you have questions about your chart of accounts or need some support with your financial operations, I’m happy to chat. At Bridgepoint Consulting, we can help your company with any of the activities/approaches mentioned above. Explore our Financial Consulting services or contact us!