Financial data is the backbone of your business; without it you can’t accurately forecast, fundraise, or make smart decisions. And more than just money in and money out, you need to understand where and how money is being spent. A well-organized and well-designed chart of accounts provides just the right amount of detail without overwhelming you with minutia and will help you understand what’s going on in your business to ultimately make better decisions.
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First of all, what is a chart of accounts? A chart of accounts, or COA, is a set of accounts, or categories, used to record transactions in the general ledger. The COA will consist of balance sheet accounts (assets, liabilities, and equity) as well as income statement accounts (revenue and expenses). Below you’ll find a list of tips to keep in mind when designing a chart of accounts for your business.
Use a numbering system
Many small and medium business general ledger tools like Quickbooks won’t automatically assign numbers to accounts in your COA, but I recommend enabling this feature to organize the COA and help quickly distinguish among account types. The first digit will indicate the account type at the broadest level (asset, revenue, etc.). For example:
10000 - assets
20000 - liabilities
30000 - equity
40000 - revenue
50000 - cost of goods sold
60000 - expenses
70000 - “below the line” expenses
Within each range, the second digit will distinguish the sub-type. Continuing with the example used above, the asset sub-types would be:
11000 - cash accounts
12000 - accounts receivable
13000 - prepaids
14000 - other current assets
15000 - fixed assets
16000 - goodwill and intangibles
17000 - non-current assets
From there, use the last digit(s) for individual accounts. For example, your main operating bank account may be 11001, petty cash is 11002, and so on. It’s always a good idea to leave a few open ranges for new accounts that may be needed down the line. You don’t want to have to completely re-do your numbering because you get a new bank account and there aren’t enough open numbers in the 11000 range.
Use clear and consistent naming
This may seem obvious, but the name of your accounts should accurately describe the type of transactions that will be posted there. Try to avoid too many acronyms or abbreviations - anyone in the Finance organization should be able to look at the account name and have a general idea of what is in that account. Payroll Expense - Salaries tells any user that this is a payroll expense account used for salaries; it’s much more helpful than simply, Sal Exp.
You should set up your chart of accounts for YOUR business. Make sure to use accounts that suit your needs. Most accounting systems will have a few default accounts set up from the start but don’t try to fit a square peg into a round hole. Don’t have a physical office? You might not need that rent expense account, but if you sell multiple products you should set up a revenue account for each product type. Try to think about what information will be useful to you in the future, even if you’re not using it now. You may only care about overall revenue today, but next year you may want more data about product mix. When in doubt, create a new general ledger account. You can always combine accounts if the extra account proves to be unnecessary, but that level of detail may be useful down the line. Creating these distinctions from the beginning ensures you’ll have useful historical data for future analysis.
Use other fields
The more dimensions you are able to use in your general ledger, the more information you can glean from one line of data. There is a fine balance between too much and too little data, but at a minimum I recommend using cost centers (often called “classes” in Gl systems) to distinguish between departments. Knowing how much your marketing team vs your product team is spending will prove invaluable when it comes time to build budgets and projections. If your accounting system doesn’t allow for multiple dimensions, you may want to create separate GL accounts for the same type of activity in different departments.
Tip # 5
Good alignment between your COA & line items used in financial models / budgeting
It is easier to translate a financial model when it consists of both the actuals and planned budgets. When teams work off of different numbers, it creates confusion and miscommunication. Teams end up doing different things and time is often wasted in translation. These inefficiencies can be greatly reduced or eliminated when the teams are aligned. It’s much easier to work on a project when everyone is speaking the same language with respect to the COA & line items. The synergy created by doing this right at the beginning should be easy to see.
Creating a chart of accounts that is dynamic and useful can and should take time. It’s especially important to ensure there is consensus across all stakeholders. It may be the accounting team working in the general ledger day in and day out, but multiple teams even beyond finance will rely on this data for decision making. Having the right information and the appropriate level of detail for use across multiple areas of your business is critical, so take the time to do it right the first time!