“A chart of accounts (COA) is a financial organizational tool that provides a complete listing of every account in an accounting system. An account is a unique record for each type of asset, liability, equity, revenue and expense.” http://searchfinancialapplications.techtarget.com/definition/chart-of-accounts-COA
In your business, you’ll have several transaction streams. You’ll invoice customers (and hopefully collect the cash from them), take out a loan, pay employees, pay suppliers, pay the rent, buy new laptops, pay the tax authorities and eventually pay yourself.
For every transaction, there is Who, When, What, How much and a tax code.
Contact names (supplier and customer) allows you to categorise “Who” for each transaction. The Chart of Accounts allows you to categorise transactions to figure out the “What” as it relates to your business.
It’s very important you spend some time and effort getting your accounting system setup with a chart of accounts that will help you understand the reports your system (and your accountant) gives you.
The chart of accounts will have the following detail included for each account code:
- Account code – normally a number (between 3 and 5 digits)
- Account name – a description of what is it, eg: Rent
- Account type – is it an asset, a liability, an expense, revenue or equity. This will allow your accounting system to product a Profit & Loss Statement (Income Statement) and Balance Sheet.
- Default tax code – this is the primary tax code for this type of transaction, which can be helpful. For example, sales will have “GST on Income” or the relevant sales tax code, whereas a bank loan will have no tax. You always get the option to change this for each transaction however it can be helpful to reduce the amount of data entry and errors.
Accounting systems may have other attributes attached to each account code in your chart of accounts (for example, in Xero, is the account code available to staff to claim expenses). The main decision you need to make is how much detail will allow you to easily see, when you run a Profit & Loss Statement (or Income Statement), whether your products make money and how much you are spending on your overheads.
For example, it’s important to know how much you’re spending on printing & stationery. However, if you have 3 vendors, it may not be helpful to have 3 account codes – in fact it may “hide” how much you’re spending. Having one account code for printing & stationery is normal practice, you then drill through to supplier reports to understand more detail on what you’re spending, if it looks unusual.
The “rule of thumb” is a set of accounts you can do the following with:
- Sensibly set a monthly budget.
- When you compare actuals against budget, areas of over and under spend are very clear, very quickly.
- When you compare your income to last month, it is very easy to see why it’s changed and hence if there is anything missing. An example would be recurring services fee, which should be similar month to month, versus project revenue which will change based on your project milestones.
- Similarly, if you compare how much you’ve spent this month compared to the last two months, issues or problems should jump out really quickly. An example would be a rent bill that’s been missed.
The best place to start is an industry based chart of accounts. This is one reason it is useful to make sure your accountant is familiar with your industry, they should be able to help you with a chart of accounts which is specific to your industry.