What Is a Chart of Accounts, And Why Does it Matter?
Running a business is no easy feat. You must juggle the demands of your customers along with keeping your records in check. Although most business owners don’t enjoy diving into spreadsheets and number crunching, keeping track of all the money that goes in and out is imperative, as it provides valuable insights into the business’s cash flow and where it’s standing.
Whether you’re a small startup or a larger franchise, you must have a good pulse on your company’s financial health. One way to keep a check on this aspect of your business is to leverage the power of a dynamic organizational tool, the chart of accounts. Learn more about this powerful analytical weapon and explore all the benefits with our comprehensive guide.
What is a Chart of Accounts?
A chart of accounts (COA) is a great way to organize all your company’s financial details smartly. It is a list of all the accounts used in a business’s general ledger in one place. Think of it as a helpful index that provides you with all the company’s financial activity details.
Companies use their chart of accounts (COA) to organize financial records and show shareholders how the business brings in and spends money. These records give businesses a clear insight into their overall financial health and ensure that the company is following all necessary financial best practices.
Types of Accounts Included in a Chart of Accounts
COA can be divided into two main account categories: the balance sheet and the income statement. These accounts are further classified into five subsections: assets, liabilities, equity, revenue, and expenses. We’ll get into the granular details of the basics of all these accounts and what comes under them below.
Assets
Asset accounts refer to any resource that adds value to your business. It can be tangible items such as land, cash, and equipment or intangible things like trademarks, software, and patents.
Typically, accountants break a company’s assets down into sub-sections based on the type of asset. This helps businesses easily distinguish the exact value of certain assets and allows stakeholders to see the diversity in a company’s value. This includes separating tangible and intangible assets, but it can also involve separating them based on whether they are operational or non-operational related and whether they are current or not current (fixed).
Liabilities
Liabilities accounts record all your business’s debts to suppliers, creditors, or other parties. They are usually classified under two categories: current liabilities and long-term (or non-current) liabilities. Current liabilities include any debts that your business will settle within a year. Short-term liabilities include payroll expenses, accounts payable, wages payable, and unearned revenue.
On the other hand, non-current liabilities are obligations that will take longer than one year to pay off. Typically, these long-term liabilities are loans or bonds. However, long-term liabilties can also include rent, pension obligations, and deferred taxes.
People commonly confuse liabilities with expenses (which we will explain more below). However, the key difference here is that liabilities are related to operations, whereas expenses are directly related to revenue. Expenses are also typically paid immediately with cash, whereas liabilities involve more delayed payments.
Equity
Equity account represents the portion of the business shareholders own. It is the financial portrayal of any company. And because every company has varying sources and types of equity, the types of accounts also differ from one organization to the other. Equity is calculated by subtracting the company’s liabilities from its assets to measure how valuable a business is to shareholders. Equity accounts can include stocks, retained earnings, and additional paid-in capital.
To determine your equity in your business, you can deduct your liabilities from your assets. This will accurately depict your total equity at any given time.
Revenue
The revenue account keeps track of all the money your business brings in from its goods or services sales. Since there may be many sources of revenue for different companies, types of sub-accounts are also more than one. A revenue account may have sub-accounts like sales, interest, and rental income.
Expenses
The expenses account refers to all the costs your business had to spend to earn money. These accounts are created for a set period of time – month, quarter, or year, and are then replaced with new ones once the period has ended. Expenses include utility bills, wages and payroll, travel expenses, and supply costs.
Components of Chart of Account
Each chart of accounts will vary based on the exact nature of your business. However, most COAs will include the main components listed below, namely the balance sheet and income statements.
Balance Sheet
A balance sheet account is a financial statement that provides a detailed analysis of what the company owns and owes. It also reveals the amount invested in your company by the shareholders. It is a snapshot of a company’s finances at any point in time.
Balance sheets display all of the aforementioned accounts:
- Assets
- Liabilities
- Equities
Income Statements
Income statements are a type of financial statement that refers to the profit or loss the company has made during a specific duration of time. It’s a way to assess the effectiveness of the company’s strategies and what improvements need to be made. It is made up of expense and revenue accounts.
Account Numbers & Sub Accounts
Within a typical COA, a sub-account column further classifies each major account type. It makes the recording of business transactions more specific, which allows detailed and accurate financial reporting.
Also, each account category will have a unique number, making it easier to sort them. The numbering also helps accountants to identify which account a transaction caters to based on the leading number. The chart of accounts follows the format of financial statements where the first set of accounts refers to the balance sheet, while the latter to profit and loss statements.
Generally, a standard coding scheme is as follows:
- Assets account: 100-199
- Liabilities accounts: 200-299
- Equity accounts: 300-399
- Revenue accounts: 400-499
- Expense accounts: 500-599
The above numbering pattern is only an example and doesn’t necessarily have to be followed. You can tweak it however you like based on your company’s needs.
Why a Chart of Accounts Matters for Small Business Owners
A chart of accounts for small business owners is significant as it simplifies the financial data, which helps you have an overview of your business. It’s an efficient way to categorize all the transactions your company has made during a specific period in a clear and organized manner.
Doing this would give your firm a bird’s eye that helps analyze the company’s value. It saves you time and effort and is a backbone for sound bookkeeping that reflects your company’s financial health.
1. Ensures Proper Financial Reporting
A chart of accounts is a powerful organizational tool that operates on a standardized framework that ensures proper reporting of financial data. The transactions are recorded accurately and consistently in the right accounts, which is necessary for generating financial statements. You can view your company’s balance sheet and profit and loss statement at a specific time to analyze how your business is doing.
2. Provides a Quick View of Debt
The chart of accounts provides a quick overview of all the debts your company owes to others – the liabilities. It offers valuable information on short-term and long-term loans. It keeps you up-to-date with the financial health of the business. By indicating how much debt a company has incurred, COA allows business owners and managers to review the impact on a company’s financial performance. This would help a company to take appropriate measures before the situation gets out of hand.
3. Helps with Financial Decision-Making
A tool that can provide a snapshot of a company’s financial health at anytime can do wonders for your business. The chart of accounts provides a clear and organized view of economic data that helps business owners make informed decisions. For instance, the profit and loss statement clearly shows what services and products are faring well and which areas of the business are driving the most costs. This helpful information can lead business owners and financial managers to rethink where they should allocate their resources to generate the most profits. Similarly, the cash flow and debt analysis equips the company with valuable knowledge that it can utilize to bring strategic changes that drive long-term growth.
4. Simplifies Tax Season
The tax season can be overwhelming, especially when you’re a small business, as there is much to consider. Fortunately, if your company has a well-structured and up-to-date chart of accounts, taxes are no hassle. The financial reports offer a quick overview of your business’s taxable transactions. Using COA, you can ensure that your business is prepared for tax season and complying with all the tax laws and regulations.
Not Sure How to Start? Let Remote Quality Bookkeeping Help
Even with all of the information provided above, organizing and maintaining a chart of accounts is a lot of work. Most of the time, small business owners wear many hats to keep their company afloat, but it’s only a matter of time before a ball gets dropped when you’re juggling so many.
The good news is that Remote Quality Bookkeeping can lighten the load by handling your bookkeeping and accounting. We offer cost-effective outsourced financial services for small businesses and franchises so you can get back to doing what you are best at — running your business.
Our skilled staff will oversee your data entry, reconciliation, and reporting. We will maintain your chart of accounts and everything else involved, like profit and loss statements, balance sheets, and more. We can also help with other business finances, such as payroll.
Are you ready to start running your business instead of stressing about the books? Then contact us to schedule a free demo so you can learn how Remote Quality Bookkeeping can help you maintain the books and keep your business financials in order.
