The chart of accounts is a core resource that is essential to the very heartbeat of your business. Despite this fact, most small business owners spend little if any time considering how to create or optimize a chart of accounts that can best serve their business.
This is partly due to the compliance-oriented nature of small business accounting, in which key decisions are made almost entirely on the basis of what’s easiest to prepare and present to the IRS and other taxing authorities.
However, this narrow approach misses a real and 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 strategies you can use to optimize your chart of accounts today:
1. Understand the standard structure, then go beyond it.
The core structure of a chart of accounts is to address five categories essential to the accounting cycle. These include:
- Assets – This tracks what the company owns.
- Liabilities – This tracks what the company owes today or may owe in the future.
- Equity – This tracks your investment in the business.
- Revenues – This tracks your company’s sales revenues, cost of goods sold and investment or other income.
- Expenses – This tracks your company’s expenses.
For each account, a record is created in the chart of accounts that includes the following components:
- Account Name – The name of the account
- Account Number – The number assigned to the account (see below for details).
- Account Type – The category assigned to this account (as noted above).
- Account Description – A description of the account and its intended uses, based on the type of transaction that should be recorded to the account.
Since more than 80% of U.S. small businesses use QuickBooks software, it’s worth noting that QuickBooks comes loaded with a set of default chart of accounts configurations for the most common business types.
However, you can (and should) go beyond this. What are the key revenue sources in your business, or your most essential cost drivers? What categories of information would most help you understand and monitor the performance of your business? Make sure your chart of accounts reflects these factors.
For example, a generic or default chart of accounts typically lumps together marketing and advertising expenses in one account, then lists postage as a single category in another account.
Today, your business may want to organize distinct accounts for digital marketing, traditional marketing, trade show marketing, channel marketing and print advertising, and you may want to organize your postal accounts to match as well (or include marketing-related postal costs in a marketing account).
2. Establish, maintain and build upon an orderly approach.
One key to building a successful chart of accounts is maintaining order, but defining the structure of that order in a way that suits your business. For example, many charts of accounts default to an alphabetical configuration, which means some of your least-used accounts may be sitting at the top of the list and some of your most heavily used accounts might be buried.
To solve that problem, many small business CPAs advise their clients to use a numbering system organized around the five account categories. One common example is this format:
- 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 also gives you ample space in the numbering schema to add new accounts in the future as your business changes and evolves.
3. Harness the power of parent accounts and subaccounts.
QuickBooks and other similar accounting systems support a multi-level account model in which you can create accounts that serve as subsidiaries under other (parent) accounts. In our earlier example regarding marketing, you might create a single parent account for marketing as a whole, and then a series of subaccounts for the individual kinds of marketing being tracked.
Another good example of how this can be used is applicable to an account such as Facilities Expenses, which can then be further examined through subaccounts specific to rent, utilities, cleaning, etc.
For example, if you run a technology laboratory you may also want to have a separate subaccount to track the costs of your clean room as a distinct item. the parent account – subaccount structure enables you to automatically ‘roll up’ expenses and view them collectively, while it also allows you to do the same in reverse, i.e. examine the individual component factors that contribute to a single overall figure.
4. Use the chart effectively, but keep it simple and support it with other tools.
As we’ve seen, you can do a lot to create and customize a chart of accounts that is ideally suited to your business. That having been said, every addition or adjustment should be justified with clear business reasoning.
Simplicity in the chart of accounts is as essential as precision. Make it too complex, and you risk seriously bogging down your accounting process and confusing things on financial reports or come tax time. On the other hand, a generic and ill-fitted chart of accounts leaves you ill equipped to make and manage the right business decisions.
Also, remember that there are other tools you can use to track and manage your business, alongside the chart of accounts. In QuickBooks, these include functions such as Classes (used in transactions to separate transactions that relate to different departments), Types (assigned to individual customers, vendors and jobs for classification purposes) and Locations (used to track data specific to individual business locations). Use the chart of accounts for its intended purpose, and then use these other tools for theirs.
Finally, remember that your chart of accounts is an incredibly powerful and central business asset. That means you may know ‘just enough to be dangerous’, so before you go and actually make changes to your chart of accounts, make sure to consult with your CFO or speak directly with your small business CPA. Walk through your requirements and objectives with them, and then let your expert advisors guide you through making the right changes for your business.
With a clearly structured and well-defined chart of accounts that is optimized for your business, you’ll be well on your way to a better understanding of your accounting, and a stronger ability to make the right decisions for your business.