How the Chart of Accounts Can Help You and Why You Should Care
As an entrepreneur, you have probably not given much thought to your chart of accounts. You may not even know what a chart of accounts is or have even seen one for your business. After all, you delegated this task to your accountant or used the automated setup function of your accounting software application. However, the initial design of your chart of accounts is probably one of the most important decisions you will make during your system setup and the key to extracting financial information for decision-making and financial planning purposes, including taxes.
The general ledger is the backbone of any accounting system and contains all the business transactions of your company expressed in monetary terms. It is structured according to the chart of accounts, which you define during the initial setup of your accounting system. The chart of accounts groups similar transactions into general or specific categories, which should reflect your business and how you want to collect and report financial information. The chart of accounts should also satisfy your own internal needs for information as well as legal and tax reporting requirements.
The chart of accounts follows a logical sequence, which reflects the way information is reported on the financial statements. In general, automated accounting systems such as Quicken, Sage or QuickBooks, among many others, will recommend a chart of accounts based on your business type (manufacturing, service, non-profit) or industry, and organize it by major accounting classifications: assets, liabilities, equity, revenue, and expenses.
You may be asking yourself: if an automated system does all the work, why bother to review or understand it? Isn’t that the reason I have an accountant to do the bookkeeping and tax filings? There are two good reasons why you should be involved in the setup of your chart of accounts. First, the suggested accounts provided by the application you are using may or may not be applicable to your business, resulting in unnecessary accounts. Second, the chart of accounts should reflect your business. No one knows your business better than you!
What are the consequences of a poorly configured chart of accounts? Mainly, rework, inefficiencies, and poor decision making due to inaccurate financial information. Your accountants or data entry personnel may get confused as to where to book a revenue or an expense item or record it inconsistently – one month in one account and the next month in another. They may require manual processes to extract and prepare the information you need to manage the business.
So, sit down with your accountant and review the chart of accounts. Add new accounts for information that you want to track, and eliminate accounts for information that you do not need. If your chart of accounts is too detailed, it may cause data entry errors and as a result, produce inaccurate financial information. Most accounting software applications will also allow you to track financial information that is not captured in your account structure. For example, would you like to see a profit and loss statement (P&L) by distribution channel, by product family, or by customer type? An accounting system that is properly configured will allow you to report this information.
If you have a system already up and running, do not despair. Most software applications allow you to change your chart of accounts with relative ease without destroying the historical data or losing the audit trail. The most important task is to sit down with your accountant, review your chart of accounts, and determine whether it is recording your business transactions according to your information needs. Make sure it is complete but keep it simple! Once you have defined what you really need, let your accountant worry about the details of the implementation.
A poorly configured accounting system can become a drag for your business. I have seen small, medium, and large companies run parallel accounting systems on spreadsheet applications because they cannot trust or use the information they receive. So, if your accounting system is not providing you with the information you need, remember – it all starts with the chart of accounts.
Lianabel Oliver Bigas, MBA, CPA, CMA is CEO and Chief Learning Officer, OBALearn (www.obalearn.com) — an online learning company that empowers professionals with financial knowledge to make better business decisions. Follow OBALearn on Facebook, Twitter, and LinkedIn to receive information on our publications and promotional offers.