1. What exactly is a Chart of Accounts (COA)?
In simple terms, it is an indexed listing of all the different account classifications for your organization’s expenses. A COA is targeted to your company’s specific revenue streams and forms the core of your accounting system.
2. Why do you need a Chart of Accounts?
Your COA helps you track and report each class of items for which you spend or receive funds. It should: align with business’ financial structure and provide the level of detail you need in your financial statements.
3. What is included in a COA?
COAs have 6 essential categories of funds to track.
- Assets — Current, fixed, A/R, inventory, long-term assets including accumulated depreciation in fixed assets (e.g., computer equipment; leasehold improvements).
- Liabilities — Current (A/P -money owed to vendors), Taxes (payroll, sales), Long-term (mortgage, other (loans, convertible debt, venture)
- Owners’ Equity (Common, Preferred, and Treasury stock (repurchased shares), retained earnings (most accounting systems will calculate this for you as default account)
- Operating Revenue — (from your primary line of business: minus sales discounts/returns) and Cost of Goods Sold COGS (the direct costs attributable to the production of the goods and services your company sells (cost of materials: direct labor, hosting). It excludes indirect costs such as marketing and sales commissions.
- Other Income or expenses — (items not related to your core business (e.g., interest income, interest expense, gain/loss from asset sales)
For more details on what is included in each category, take a look at my previous post: Creating Your Chart of Accounts.
4. What’s the deal with all the numbers?
Once you are comfortable with your basic categories, you need to create a numbering system for your COA. These are usually 4 digits long. The convention is that each category of accounts shares its first two digits, while the following digits denote subcategories. For example, you might use a series of numbers beginning with 1,000 for assets (with 1,001 for the cash subcategory), while starting with 2,000 for your liabilities (and using 2,001 for your accounts payable subcategory).
Flesh out your COA as fully as you can, leaving room for future account categories. One key thing to remember is that it is not static. It can and should change as you develop new revenue streams and as the types of expense you have change.
5. How can a COA help drive my business decisions?
While they might seem like some arcane accounting convention, the structure embedded in a COA helps you interpret your financial statements. Making it intuitive helps you glean the maximum amount of financial information from your statements in the most efficient way possible.
The way a COA is organized makes it easier for you to isolate and analyze discrete business business functions. It helps you to disaggregate and understand the composition of your revenue as well as the relationship between revenue and specific categories of expenses. In other words, it’s a tool that allows you to measure the value-added you are gaining from your business activities.
You don’t need to reinvent the wheel; there are COA templates available. But use them only as starting points to help you tailor yours. The purpose of a COA is the customized picture and deep insight it gives you on your business. Make sure when you set yours up that you choose accounts that are relevant to your business.
Confused about or need help setting up your Chart of Accounts? Let us know in the comments section below or contact Early Growth Financial Services for a free 30-minute financial consultation.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial and accounting services to companies at every stage of the development process. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.