As an English major who wandered into accounting, I often tell people I help clients understand the stories behind their numbers. Who’s the hero? Who’s the villain? Where are we in the plot? And if the story of your business is headed toward tragedy, how can we play with the characters to achieve a happy ending? Oddly enough the work often begins with their chart of accounts. Stay with me for a minute here. I promise this will go beyond the boring accounting class you slept through. Accounting is a blend of protocols and rules mixed in with some art and creativity. And one of the places you can see that mixture play out is in the business’ chart of accounts.
The chart of accounts is that list of categories that an accounting system uses to organize the financial information for the business. It has certain universal conventions that apply to all businesses. For example, it has a particular order that corresponds to how information displays in the financial statements. Asset accounts get listed first, followed by liability accounts, and then equity accounts. Those are three sections of the balance sheet. We cross over from the balance sheet accounts to the income statement accounts – revenue, then cost of goods sold, with expenses rounding out the list. Ho hum I hear you saying as your brain gets lost in accountingspeak.
Here’s my metaphor to explain this otherwise boring artifact of the accounting landscape. Imagine a skeleton. Let’s say the skull is the cash accounts with the neck being the other assets. And the arms could be the liabilities with the rib cage taking care of equity. The pelvic girdle will be the revenue accounts. One leg could stand for our cost of goods sold while the other leg takes care of operating expenses. Okay, got your picture of Mr. Accounting Skeleton? That’s the basic foundation of your chart of accounts. Sort of like a house that’s been framed before the drywall goes up.
Now the next level in this metaphorical picture requires you to imagine lots of tiny little buckets hanging off all of those bones. On the skull we might have a bucket for your operating checking account and another for your payroll checking account. Depending on how your business uses credit, the arms might have a bucket called accounts payable, another called car loan, and another called line of credit. On the leg for operating expenses, we might have buckets labeled advertising, rent, insurance, payroll, etc. The point is that the bones account for the underlying structure required to organize the financial information in any business anywhere and the buckets capture the specific kinds of information that pertain to your unique business.
So why did I start this piece by declaring that avoiding a business tragedy can begin with the chart of accounts? Because many small business owners I encounter have trouble understanding and interpreting their numbers. Part of their problem stems from how poorly organized their information is. Almost nobody creates their chart of accounts from scratch. Their CPA created it for them. Or QuickBooks created it for them as part of its easy simple set up interview. Odds are that however you got your chart of accounts, it didn’t factor in your specific circumstances. Therefore, it may not be giving you the whole story.
Classic example. Every business should be looking at an income statement that includes Cost of Goods Sold (COGS). It’s the only way you can see gross profit and margin. Critical metrics to understanding and monitoring the health of a business. But when you start a company in QuickBooks and create a chart of accounts, it rarely includes a COGS section. That’s because the software asks you if you are a manufacturer who makes stuff or a retailer who sells stuff. If you answer “yes”, QuickBooks will create an inventory account. And that will trigger a COGS account. But if you don’t make or sell stuff, QuickBooks will know that you don’t need an inventory account and will assume you don’t want a COGS account.
Sometimes the problem is too little visibility into the information. I often see a single solitary income account called Sales or Revenue. Well, what if you run an auto repair shop? You probably make money by selling labor, parts, maybe some money comes in from towing or from commercial fleets. My point is that you will probably find it more useful to see the types of revenue you generate reflected on the income statement. That all starts with the chart of accounts.
Other times the problem is too much information. I had a client whose chart of accounts included accounts for the telephone land line, another for the fax line, and more accounts for every single cell phone provider she reimbursed her staff for. She had no idea how much she spent for this critical communication tool until we combined them all into one account called telephone expense. After we did that, she could see this expense line as a percentage of overhead. She could track its trends over time. She could monitor its changes relative to staffing fluctuations.
Strong buildings require a solid foundation. Your chart of accounts is more than just a list of categories. It is the foundation of how your financial information presents itself. It’s responsible for what you see and monitor, and perhaps more ominously, what you do not see and monitor. You should consider the chart of accounts to be one of the places on your financial landscape where you can creatively influence what you monitor and measure. What gets measured, get managed… you know the drill.
If your chart of accounts is poorly designed and fails to help you manage your business, give me a call. I’m a numbers nerd, so I enjoy helping business owners discover how clarity and simplicity make the job of managing the business so much easier.
Wishing you lots of positive cash flow.