One of the most important things you’ll do in your business is set up and maintain your financials properly. Categorizing expenses, keeping an eye on the money going in and out, as well as managing the details of your revenue and inventory are crucial. And all of this means you need to Set Up Your Chart Of Accounts the RIGHT Way to track it all properly. It may sound difficult to many business owners, but it is possible!
Set Up Your Chart Of Accounts the RIGHT Way
So what exactly is a chart of accounts? It’s a tool that lists EVERY account in your accounting system. Think of it as the “buckets” where you put every business transaction. By doing this, it makes it possible to review the performance of your business at a glance. That is why it’s so important to make sure the chart of accounts is organized correctly!
It will give you a clear picture on WHERE your money is going and will provide you with all the information you’ll need to make business decisions. It is also the basis for all of your accounting reports and will be the main way you will create financial statements and file tax returns.
Below are some common tips you can follow to make sure you set up the chart of accounts correctly the first time, which will ultimately save you time, money, and lots of frustration!
1. Set Up Your Chart Of Account Yourself
It may be tempting to let a tax person define everything for you that will help to make your tax filings easy, but that means you’d have to categorize everything the same way all year long… not just for tax time. You need your accounts to correspond to how you actually manage your business and for all of the reporting and analysis you do. Not based on how the IRS handles deduction and credit rules.
2. Set Up Matching Revenue and COGS Accounts
You want to measure your margin closely all year, as it’s more than likely the single most important metric you need to follow in your business. In order to correctly calculate your margin by product or service line, you’ll need to set up matching revenue and cost of goods sold (COGS) accounts.
Revenue
Think about the different ways your business brings in revenue and group them into broad functional categories. These will become your primary revenue accounts. You can use sub-accounts to show additional detail, but make sure you keep your broad accounts general.
COGS
Now you can create matching accounts for each revenue account. Just remember to break out COGS into materials and labor, so you can eventually track what you spend on raw material versus people.
Now that your accounts are set up correctly, calculating your margin by product or service line is simple.
3. Keep Your Chart Of Accounts As Is
Even if you’re a small business, chances are you will have many different categories you will use and it can get overwhelming at times. That means if you don’t keep your chart of accounts organized, your Income Statement and Balance Sheet may be misrepresenting what is actually happening. This can lead you to make bad business decisions on factors that aren’t accurate. Therefore, you’ll want to make sure you use these quick tips to keep your chart of accounts organized, without messing with your original set-up.
Create a Logical Hierarchy
If you create a hierarchy of accounts, it will make the reports that you create much more useful. You will be able to take a high-level view of how your business is operating and drill down into the detail account items if you need to learn where things may be going wrong. Just make sure you keep the chart of accounts in check and limit your hierarchy to no more than four levels. Make sure all of the accounts are grouped appropriately or your new hierarchy may do more harm than good.
Group Accounts Sensibly
Organize your accounts into meaningful groups. Generally, your Level 1 themes would be Assets, Liabilities, Equity, Revenue, COGS and Expenses. Keep it simple and straightforward. Now, you can create sub-accounts, or Level 2, 3 or 4 accounts based on how many items may fall under your main Level 1 items.
Most important, DON’T let accounts suddenly multiply by creating new accounts on a whim. It can be tempting to create too many accounts and the expenses section can be a challenge to maintain for many business owners. Work to keep it simple!
Level 2 – Try to only have 3 overall accounts for your expenses: General and Administrative, Sales and Marketing, and Research and Development. This will help you calculate each as a percentage of revenue, which is how many businesses monitor their Operating Expenses.
Level 3 – Within your Level 2 broad categories, now you can create more details which should still be no more than 10 accounts. They should be grouped in a way that would help you answer questions about your business.
Level 4 – Your lowest level of accounts should still be a category of revenue or expenses (not a customer or vendor). But this would be your lowest level of detail on the items you want to track.
Your goal is to create a chart of accounts that doesn’t need to change much year over year. This way, you can easily compare the performance of different accounts over time, which can provide valuable insight into how you are managing your business’ finances.
Wait to Delete Old Accounts
Make sure you do not mess up your books by deleting old accounts in the middle of the year. Merging or renaming accounts can create headaches come tax season, so it is always a best practice to wait until after a close to merge, rename or delete accounts.
By following these suggestions, you will hopefully have a much better time reviewing your Profit and Loss and Balance Sheet statements. You will have more knowledge and confidence to successfully tackle what may come your business’ direction. While some steps may be slightly altered for you based on the type of business you have, everything will be more concise and easy to dig into details with. Remember, you have the flexibility to tailor your chart of accounts to suit you! Make better decisions for your business with the correct information.
Please reach out if you should have questions or need any support to Set Up Your Chart Of Accounts the RIGHT Way.