Understanding Your Company's Chart of Accounts
Over the course of its lifetime, your business will have thousands of transactions from buying supplies to paying wages and issuing invoices – you have to record it in your company’s books.
It’s important to record it in the right account, as it forms the basis of your company’s bookkeeping. The problem, however, is that if you often don’t know which account to record it in your books can get messy, quickly.
So, here is a quick overview of things to help you along the way!
What exactly is a chart of accounts?
The Chart of Accounts is a complete listing of every account in your company, broken down into subcategories for listing transactions in your accounting system.
The main account types in your chart of accounts are:
Revenue. This is the income your business generates, either through sales or services you provide to your customers. Remember that revenue should not be confused with profits.
Expenses. In order to run your business, it’s inevitable that you’ll have expenses. This can be anything from subscriptions, wages, and consumables. When you deduct the expenses from your revenue, you get your profits.
Assets. An asset is a resource that a company owns or controls that will provide future benefit. As a simple example, a large expense is often considered an asset if it’s something that will also be used by and benefit the company in the years to come.
Liabilities. Liabilities are your obligations to other parties, or, in simpler terms, something that you owe to someone else. Although not necessarily the case, it’s usually a sum of money. When you deduct your liabilities from your assets, you get your equity.
Equity. Equity is the capital in your business. It’s the money you invest in the business, or, in other words, equity can be defined as the assets which are created by the company after discharging its liabilities.
These account types are then followed by sub-categories. As an example; an Expense could be “Office supplies”, or “Bank fees”, and each of these would be considered an account in your chart of accounts. How many, and exactly what accounts would depend primarily on the functions and structure of your business. How do you want to see your financial statements? Do you need to see exactly what you spent on payroll fees each month? Then you would setup an account called “Payroll fees”, which would live under the account type “Expense”.
Keep your accounts clean and tidy. Avoid assigning too many accounts and creating clutter in your financials. Make sure you’re consistently booking transactions to the correct accounts. If you create too many accounts, there will be transactions all over the place and not give you a clear picture of your finances. If you create an account for “Office supplies” and one for “Office expenses”, what exactly are each of these for?
The chart of accounts gives you everything you need to assess the financial position of your business. Think of it as a map that shows you your business and its various financial parts.
When you have this map, it’s easy to distinguish all your business’s accounts and makes it easy to know exactly which transactions should be recorded into which account. This eliminates confusion, giving you an accurate representation of your company’s financial health, and makes it easier for you to make better business decisions.
Understanding the overall setup of your chart of accounts can go a long way in gaining an understanding of how transactions are booked and make you feel more in control when looking over your financial statements.
