Chart of Accounts: mapping the genome of your business

To use this medical metaphor financial records will be a meaningless jumble of nothing, a blob of ectoplasm, without a chart of accounts. The chart is a map of the business – a list of unique nominal ledger accounts or records that break down the business into its constituent parts.

This chart can be laid out in any pattern but to be most useful there should be a logic, methodology and consistency to support it. The list of accounts and their balances at any particular point in time is called a Trial Balance. This is just a list, so in itself is not terribly helpful apart for checking the control of debits equalling credits. Producing financial statements is the application of this database to show the performance and position of the business.

The chart of accounts is generally grouped into ranges of accounts:

• Assets
• Liabilities
• Equity
• Revenue
• Cost of Sales (or direct costs)
• Expenses (overheads or indirect costs)
• Non-operating income and expenses

Depending on the business these ranges may be further subdivided into income/cost centres and/or business divisions….or really in as many ways as management want to look at the business. The more detailed the chart then the more possibilities for analysis – although each layer of additional detail requires more work and increases the chance of inaccuracy or error.

Businesses want as much useful information as possible, while avoiding paralysis by analysis. If the objective is to populate a tax return a limited chart is all that is required – albeit with some specific requirements. A solo or micro business may not need a long list of accounts if it is relatively easy to control. However more detail is always better than less as more reporting options become available – this needs to be balanced against the effort and resources required. The determining factor is what information you require, or may be likely to require in the future.

For ease of use and versatility accounts are nearly always given codes. These can be numerical, alphabetical or a combination of both. The number of digits will depend on the level of detail and hierarchy chosen. Depending on the recording method (usually software program) the basic structure may be pre-determined but otherwise there is no set format – but again logic and consistency should prevail.

The reason the chart of accounts should be decided at the outset of your business is that the more time goes by, with data collected, the harder it is to change your chart or add in more detail – harder but not impossible! For instance do you only need one account for income or multiple accounts for different revenue streams or products?

Designing the chart of accounts may seem like a daunting task with a lot of considerations, present and future, to take into account. However you generally don’t start from scratch. There are numerous pro-forma lists around which may suit your industry - perhaps within the software program used or on the Internet. Your accountant will probably have a suitable structure you can use and in any event they should be consulted for their input and feedback before implementation.

Debits and credits – what are they and what do they mean?

Debits and credits are the names given to each side of a double-entry bookkeeping transaction. Business transactions are stored in records or ‘accounts’ whereby similar transactions are grouped together. These accounts are made up of debits and credits and will show a balance which is total debits less total credits (this may be zero in some cases).

By convention debits are on the left and credits on the right (or sometimes shown as positive or negative numbers respectively). This is purely for consistency and ease of use and does not in itself have any meaning.

As the system has to have a point of origin, assets are debits and liabilities credits. This doesn’t mean you can’t post the credit side of a journal to an asset account – you can, it just means that it is a reduction in the book value of the asset (most likely depreciation). Similarly you can debit a liability, which reduces the value of that liability – such as a payment to a creditor reducing what you now owe to them. Equity (or Capital) is usually treated as a separate category but it is really just a (non-current) liability of the business to the owner or shareholders.

OK, so that is the balance sheet side of double entry but because it is a self-balancing system the principal equally applies to the profit and loss account. Here debits are costs or overheads and credits are income or revenue – you can think of it as income being an increase in owner’s equity.

DEBIT	CREDIT
Asset	Liability / Equity
Reduce Liability	Reduce Asset
Expense	Income
Reduce Expense	Reduce Income

A frequent comment on this is “but I have a positive bank balance which is in credit”. This does cause considerable confusion, as it is where most business owners are likely to come across the debit/credit terminology. It is not a contradiction – to the bank your bank account is a liability, they owe you that money. It is perhaps just egocentric of them to display information to the customer from the banks point of view.

A more helpful way to look at this is to equate it with buying something on credit which is very common and easily understood. In bookkeeping parlance you are crediting your general ledger credit card account and debiting whatever the transaction was – either an asset or an expense.

The terminology is often abbreviated as debit (Dr.) and credit (Cr.). An example of a journal transaction as it would be written or posted to a ledger account – an electronic bank payment to pay for a reference manual:

Dr.	6-3300	Books & Periodicals	$50.00
Cr.	1-2010	Bank Account		$50.00

The above codes are fictitious and will depend on the structure of the chart of accounts – which will be subject of a future post…..

A change is as good as a rest...or even better

Finally, I’m happy and everything is in its place (sort of!). Moving office can be a daunting experience but once done, brings a great sense of satisfaction and an impetus to do more work (or write a blog!). Not that my experience was a huge change in real terms – except to me! I swapped my office and bedroom.

To put this in context the bedroom was at the back of the house overlooking a park – great outlook and fantastic light. The office was in the ‘spare room’ that is a bit smaller and much darker as it doesn’t have much direct natural light – which I love. That didn’t make for an overly productive work environment but my mindset was that the bedroom should have precedence and be in the nest room. There is an easy chair in the bedroom with a footstool – I love it but was always banging my shin going around the bed. After hearing this a few times my partner suggested why not swap around the rooms. Initially I didn’t think much of this but it got me thinking……

I spend much more of the day in the office whereas the wonderful light in the bedroom was largely going to waste. The easy chair could also stay in the ‘new’ office with more room for the footstool – a great place to read documents and texts. There was a phone connection in both rooms so that wasn’t a constraint. Ok, decision made…work to do.

Well, it didn’t really take that long to do and after a few trial layouts (and more advice) I had a great office – better structured and above all, a better working environment. The other side of this is there is also a terrific new bedroom – although it is slightly smaller it is a different shape, which is actually far more conducive to fitting in bedroom furniture. The fact that is darker is also a good thing and aids sleep. The other benefit of the big move was that it was an excellent opportunity for spring-cleaning and re-organising (and finding things that I forgot I had!).

Now why am I sharing all this? I know one of the reasons I enjoyed the whole exercise was that I like change – but only if I think (at the time) it makes me more efficient with my use of time or resources. Shifting around my furniture from time to time is something I’ve always done – without analysing the why too much. This is also how I approach my spreadsheet financial models.

Constantly thinking about ways of making them more efficient, smaller in size or with less detail – while at the same time giving more relevant results and being more user-friendly – this is especially important if others are to use them as well. Starting to use a spreadsheet that has been developed by someone else usually has a steep learning curve and the more sophisticated the model the longer this takes. Of course a good modeller will use methods and techniques that can cut this down greatly (such as putting assumptions and variables together on one page rather than scattered throughout the spreadsheet).

From time to time this means that the whole spreadsheet gets turned on its head if you come up with a different way of looking things (such as allowing for a breakdown by day if you’re looking at coming up with both weekly and monthly data – and that doesn’t have to be as hard as it may sound). Also if the you or the client wants to introduce another variable into the picture (such as multiple cost centres with individual reports) that might require a radical reworking of the model.

Of course the other side of all of this is that you can’t spend too much time on change or re-organisation or do it too often – it can be a good way to prolong procrastination or to defer something. However if done right it is another and better way of looking at things, whether that is your workspace, personal life or a financial model of your business.