The Chart of Accounts (COA) is the foundation of financial reporting, as every aspect of your financial reporting is directly or indirectly sourced from your Chart of Accounts. An organized, logical Chart of Accounts can be drawn on to both combine and parse a business’s financial records for management and/or other stakeholders.
Unfortunately, in many businesses the Chart of Accounts is far from optimized. It can be too simple and therefore unable to detail what is really going on “under the surface.” Or it can be too complex and hard to pull together in any meaningful way. Or it may have lost its effectiveness over time, as new codes were haphazardly added without regard to the overall logic of the original design.
A new or revamped Chart of Accounts can immediately improve your management and stakeholder insights and drive your business to new levels. We have put together five tips for designing or redesigning your Chart of Accounts.
- Focus on what management needs in its regular reports, not just what you need for tax reporting or investor reports. A Chart of Accounts organized for the benefit of the IRS or investors is unlikely to organize things in ways that will help management make improved decisions on a daily, weekly, or monthly basis.
How does your organization organize its budget? How does your organization set its prices or rates? How does your organization monitor profit margins? How does it monitor its supply chain? How does it factor in expenses?
The answers to those types of questions are critical to business owners and managers to plan and make ongoing decisions, so these are things they need to be able to quickly and clearly assess in order to make good informed decisions and maximize returns. The first step to creating or revamping your Chart of Accounts should be to set it up in a way that can generate reports that will reflect the way management visualizes the business. At MCDA CCG we have software and solutions to reorganize your accounts for their purpose when the time comes. We can focus your Chart of Accounts and make it work for you to quickly assess results and allow you to make informed decisions and maximize results.
Use numbers for coding, not alphanumeric or other methods. While this is quite normal for many companies, some companies – especially small ones – unwittingly start off with homegrown codes like A101 or B-SALES. This type of alphanumeric coding makes it difficult to sort and connect relevant accounts, and is susceptible to errors in data entry.
One common numeric method uses the acronym ALERCE –Assets | Liabilities | Equity | Revenue | COGS | Expenses:
Assets – 1xxx
Liabilities – 2xxx
Equity – 3xxx
Revenue – 4xxx
COGS – 5xxx
Expenses – 6xxx
Make it detailed, but not too detailed. Chart of Accounts is an organizational tool, and it can be too simple to be useful, or it can be too complex to aggregate and understand. If you had a filing cabinet with all papers related to “assets” in a single folder, it would be hard to find any one item or pull together a group of related assets. On the other hand, it would be equally cumbersome to have a room full of filing cabinets full of folders with only one or two items in each.
The typical recommendation for a COA is to have main categories (like the ALERCE example above) and then no more than two or three sub-categories within each. So, for example, you might have:
This level of detail should allow you to generate financial reports with broad categories and calculations, plus be able to break down those categories into manageable component parts for further analysis as required. At MCDA CCG we can help create meaningful reports that work for your business and help you with any analysis needs you may have.
Specifically assign someone the responsibility of maintaining the Chart of Accounts. Once a framework for your Chart of Accounts is put in place, it is important to maintain it according to the logic and rules used to create it. This can be problematic over time if different people or departments begin to add codes or categories in an ad hoc manner. By assigning one person the responsibility of monitoring any changes, you are more likely to keep your Chart of Accounts optimized and able to effectively inform management of critical situations before it is too late.
Consider outsourcing your Chart of Accounts setup or overhaul. Designing or redesigning a Chart of Accounts is a rare event for a business – you might do it once in a five to ten year period – while a bookkeeping or accounting service like MCDA CCG may go through the process regularly for different clients and be familiar with the best practices and subtleties. Be careful, though, that they follow tip #1 above – focus on what management needs.
The Chart of Accounts can be a powerful tool for analysis, planning, and growth, but only if you approach it the right way. Focus on what it can tell management, rather than the IRS, and create and maintain a logical blueprint that won’t become bloated and inefficient over time.
If you’re ready to get your Chart of Accounts up to date, MCDA CCG can help. We offer bookkeeping and accounting services, along with reporting and payment solutions. We’ll provide you with a team of bookkeepers with expertise in your industry to make sure you’re getting the most out of all the work you do. We can work with your existing accounting software and tools, or can help you make the move to newer technologies. Call us today and find out how our bookkeepers or interim fractional CFO’s can help you and your organization move to the next level.
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