One of the first steps of getting your accounting system set up, is getting a solid chart of accounts for your business. Depending on what sector you fall in – your chart of accounts will be different. A business needs and should want to know where funds come and go. Your chart of accounts is a tool for gathering and organizing this type of information and directly feeds into your balance sheet and profit and loss statement.
A business must have useful information in order to be able to survive in today’s competitive business world. Your accounting system should be designed and used to provide much of this detailed, summarized, and needed information.
Here are 7 tips in developing and designing an effective chart of accounts for your business.
- Accrual or Cash Basis. You’ll need to determine which accounting treatment to go under. From my experience, I’d suggest accrual basis of accounting. However, depending on your business model (if non-inventory) you might want to check out the benefits of doing a cash basis of accounting. The basis of accounting, will be the first point to dictate your COA.
- Balanced Detail. There is a trade-off between simplicity and the amount of detailed information your business needs. The devil is in the details, and you want to be able to make good use of the information in your chart of accounts. Finding a balance between a too simple basic chart of accounts and a mega detailed COA is recommended.
- Match your COA to your business. Your type of business (producer, processor, distributor, retailer, service provider, etc.) will dictate your Chart of Accounts. Even businesses that are the same type and industry might have special or unique requirements. While a service business may not have a need for an Inventory account, this is a necessity for a retailer. One company may have 8 different cash accounts, while another one has one.
- Knowing your audience. Special consideration should be given to any regulatory reporting requirement. This would be to your state, local, or federal government. Creating a chart of accounts to include key information needed to prepare tax returns or needed for any special regulatory reporting requirements is highly recommended. For example, if 280E applies to your business – I’d recommend including a 280E reserve (liability account) and 280E allocation account (expense account).
- Account Numbering. A standard chart of accounts is organized according to a numerical system. Account numbering allows for better decision making and reporting.
- Sub-Accounts. Sub accounts are a fantastic way to measure how certain components of an overall expense affect the balance. Sub accounts are optional, and allow you to track financial activity within a particular account at a finer level of detail. Sub-accounts can be used to help track expenses when several different activities may be funded by the same account.
- Key Integration. Adding a detailed list of your vendors, customers, products to integrate with your chart of accounts is fundamental. Not only can you analyze the detail on your customers and suppliers, but you can also match up certain products or services to your specific chart of accounts. Automation is key!