Have you ever looked at your financial statements and just thought to yourself, “I have no clue what this is telling me?”
Well, if you have, you aren’t alone. I’ve found this is common among many small business owners. The usual culprit is that your chart of accounts has been set up by using the standard accounts from your accounting system and things have become disorganized over time.
Here are my Chart of Accounts Best Practices:
#1 Use account numbers
This will allow you to organize your accounts in a way that makes sense to you and not just alphabetically. Also, it allows you to have more clarity around balance sheet accounts and P&L accounts. You don’t know how many times I’ve seen a small expense being booked to “Software” which was a fixed asset account. If you don’t have account numbers in place, you can’t easily identify if you are coding a transaction to an expense or an asset account. I have a fairly standard numbering outline that I like to use:
1000 – Asset Accounts
2000 – Liability Accounts
3000 – Equity Accounts
4000 – Revenue Accounts
5000 – Cost of Sales Accounts
6000 – Expense Accounts
7000 – Expense Accounts
8000 – Other Revenue Accounts
9000 – Other Expense Accounts
#2 Group accounts into meaningful buckets
I like to look at how a business operates and group accounts into how things are happening. For example, if you rent office space, I would recommend an Occupancy expense grouping and then nest all the expense accounts related to your office space under that. Another example could be Payroll & Subcontractors where you nest all costs associated with those under that main expense account. The groupings work best with expense accounts, but you might have reasons to do this with your balance sheet accounts like Payroll Liabilities and nesting the different sub-accounts under there to track them individually. The best part of groupings is that you can condense your view of the financial statement to get a quick high-level view of your business. It pulls you out of the weeds.
#3 Split out variable and fixed expenses
I like to organize expense groupings for a business by most variable to the most fixed. A lot of those variable expenses will actually end up in your Cost of Sales area on your P&L. This means that the more you sell, the more you expect those numbers to increase and the reverse being true. Depending on your business, sometimes payroll will be in Cost of Sales and sometimes it won’t. Marketing & Advertising is a grouping that I usually put at the top of the expense listing AFTER Cost of Sales. Yes, the more you spend, the more sales you expect, but that isn’t always the case. There is a pretty strong relationship, so that’s why I want to put that towards the top of the expense listing. Occupancy expenses are usually towards the bottom of the expense listing because the amounts are fairly constant and are not impacted by sales.
#4 Keep your reports short
Your Balance Sheet and P&L should NOT be longer than a page each. This is because it is just hard for us to digest large amounts of information at once. The longer a list – the less likely someone will spend time looking at it because it is overwhelming. Account groupings is a way to have detail but still be able to keep your reports short. But, you should also just think twice before adding more accounts to your books. If you find that just one transaction is coded to an account a year, then consider whether you can merge that account with another one. Whenever you create a new account, just ask why you are doing it. Will this add more value to my reporting or will it make things more overwhelming?
Those are my tips to help you better understand your financials. When you can do that, you can use them to help make informed decisions about your business.
If you ever need help reorganizing your chart of accounts, just reach out! I’ve been creating order out of chaos for years and love implementing these Chart of Accounts Best Practices so that they can truly make the financials in QuickBooks and other accounting systems more understandable to business owners.