Organizing your chart of accounts is a crucial part of any efficient and reliable accounting system. The chart of accounts is the foundation of your recordkeeping. Small business owners must have an organized chart of accounts to help quickly assess business health, view the movement of funds, and make important decisions timely.
An organized chart of accounts will also help you (or your accountant) create accurate and punctual financial reports and tax filings. As a small business owner, having all your accounting data, accurate and organized on one page, is an advantage.
Before We Start
Let's briefly cover the parent accounts, these parent accounts are the main 5 accounts that all other accounts will fall under.
Assets: This is what your company owns, and anything of value that can be sold for cash. Including accounts receivable, and any monies owed to you on an invoice.
Liabilities: This is what your company owes, or will owe in the future. Including taxes, and any debts.
Equity: This is your investment in the business, your skin in the game. If you are a freelancer, this does not apply to you.
Income: This is the money you earned from doing business. This also includes investment income, which you could earn from any company investments.
Expenses: This is the money your business spends to make money. This includes costs like utilities, supplies, and rent.
Organizing Your Chart of Accounts
Now, you will learn how to organize your chart of accounts. Let's get started! First, take a breath, get a sheet of paper, a pen, and write.
List out the parent types of accounts (asset, liability, owner's equity, income, and expenses). Assign numbers to the parent account types, these are standard for most accounting systems. Then add the name of your accounts within the respective parent account type. Remember, you can always add more account names to your chart later in time, so just write down the ones that come to mind for now.
Here is an example:
Asset Accounts - 1000 thru 1999 - Cash, A/R, Supplies, etc.
Liability Accounts - 2000 thru 2999 - A/P, Unearned Revenue, etc.
Equity Accounts - 3000 thru - 3999 - Small business owners capital
Income Accounts - 4000 thru 4999 - Revenue, Investment Income, etc.
Expense Accounts - 5000 thru 5999 - Marketing, Wages, Rent, etc.
After you've listed out all your accounts, you should add specific descriptions to your chart of accounts. Adding a description to each business account will be helpful to you, and your current and future employees. Because it will serve as a universal meaning to each account, and help reduce account meaning assumptions and possible entry errors.
Completely Organized Expense Account Example:
4010 - Marketing Expense - Costs of ads, promotions, etc.
4020 - Wages Expense - Expense incurred for hourly employees
4030 - Rent Expense - Cost of occupying rented facilities
4040 - Utility Expense - Cost for electric, heat, water, and sewer
Once this is complete, share the accounts and descriptions with all who need to know.
Utilize Your Chart of Accounts
You can use your organized chart of accounts to assess your business's financial health and plan for the future. Here are a few ways any small business owner can fully take advantage of their newly organized chart of accounts!
Accurately Track Revenue and Value - Your chart of accounts can track where money is coming from and, it can also tell you the value of your assets if you ever needed to liquidate.
Track Your Spending and Reconcile Budgets - The chart of accounts can track where money is going, help you make better spending decisions, and highlight key areas that need to be cut or reduced.
Evaluate Your Debts and Plan - An organized chart of accounts can provide an overview of your short-term and long-term debts, and allow you to manage them efficiently. And provide a data set to create a forecast to plan for recurring expenses.
File Your Taxes - If you maintain and manage your chart of accounts, tax season will be a breeze. An organized chart of accounts will provide all income and expense numbers needed for the IRS at tax time.
Maintain Your Chart of Accounts
An organized chart of accounts is great, but a maintained chart of accounts is another level! As your small business grows, so will your accounts. Remember to add new accounts when one similar does not already exist.
As a small business owner, you do not want to start lumping transactions into accounts they don't truly belong in. This will cause a mess if you ever plan to get funding or even sell and exit. Keep in mind the importance of the chart of accounts. It is the backbone of your accounting records, so have integrity and ensure entries are properly booked, and use the data to strategize and grow!