A chart of accounts is a tool used in small business accounting to organize the key accounts that contribute to the creation of financial statements. The chart of accounts is a useful document that allows you to present all financial information about your business in one location, providing a clear picture of the financial health of your company. The chart of accounts organizes your finances into the following five account types: assets, liabilities, equity, revenues, and expenses.
These topics will assist you in comprehending what a chart of accounts is and how small businesses utilize it:
What Is the Function of a Chart of Accounts?
What Are the Five Most Important Accounts?
Why Is a Chart of Accounts So Essential?
What Is the Function of a Chart of Accounts?
The chart of accounts is used by small businesses to organize their complex financial information into an understandable format. It is the initial step in establishing the accounting system for your business. The chart of accounts clearly separates your revenues, expenses, assets, and liabilities to provide an accurate financial snapshot of your business.
The chart of accounts categorizes your financial accounts by number. The majority of businesses adhere to this consistent and widely accepted account numbering system:
- 1000 – 1900: Assets
- 2000 – 2900: Liabilities
- 3000 – 3900: Equity
- 4000 – 4900: Revenue
- 5000 – 5900: Expenses
Although it is not required, businesses typically use the same numbering system for the chart of accounts because it makes it easier for an accountant or bookkeeper to translate the data into standard financial reports. Those who have worked with a general ledger You’ll notice that the accounts in the ledger are identical to those in the chart of accounts.
What Are the Five Most Important Accounts?
The five major account types provide the structure for your chart of accounts by separating the information into distinct categories. Multiple essential financial reports are constructed using the same five account types. The five major account types that will be used to construct your chart of accounts are as follows:
- Assets: Assets are resources that can be converted into cash and therefore have a monetary value. Your accounts receivable, vehicles, property, and equipment are examples of assets.
- Liabilities: Liabilities are debts owed by your business to others. This would include accounts payable, any taxes owed to the government, and loans that must be repaid.
- Equity: The function of equity in the chart of accounts varies depending on whether your business is organized as a sole proprietorship, an LLC, or a corporation.
This may include Owner’s Equity or Shareholder’s Equity, depending on the structure of your business. Equity is calculated by subtracting a company’s assets from its liabilities.
- Revenue: Revenue is the amount of money your company earns from the sale of its products or services.
- Expenses: Expenses are the costs incurred while operating a business. This would consist of your office’s rent, utilities, and supplies.
Why Is a Chart of Accounts So Essential?
The chart of accounts allows you to organize the complex financial data of your business and distill it into logical account types. It also lays the groundwork for all of your company’s essential financial reports. However, a chart of accounts is more than merely an organizational tool. Having all of your financial data in one location and being able to see how the various accounts relate to one another can provide valuable insights into the performance of your business.
Here are some ways in which a chart of accounts can be advantageous to your business:
- Recognize Your Earnings
A chart of accounts provides greater insight into your company’s revenue than simply the amount of money earned. It illustrates the peaks and valleys of your income, the available cash flow, and how long it should last given your average monthly business expenses.
- Get a Grip on Debts
A chart of accounts provides a clear picture of your short- and long-term financial obligations. Your chart of accounts can assist you in determining how much of your monthly income you can afford to pay toward your debts and in developing longer-term plans for debt repayment.
- Spend Smarter
Seeing a straightforward list of everything you spend your hard-earned money on isn’t always enjoyable, but the chart of accounts can provide you with valuable insight into your spending habits. You can manage your essential reoccurring expenses, such as rent, utilities, and internet. You can also examine your other expenses to determine where you can save money if necessary.
4. Enhance Your Reporting
A chart of accounts organizes your financial accounts into a streamlined, numeric system. Having an accurate chart of accounts facilitates the development of in-depth financial reports, such as a cash flow statement, balance sheet, and income statement, to help you comprehend your company’s financial position. You can modify your chart of accounts so that its structure corresponds to the particular requirements of your business.
- File Taxes
A properly organized chart of accounts simplifies tax season, which is an added benefit. The chart of accounts keeps track of your business’s income and expenses, which must be reported on your annual tax return. If you want to create a customized chart of accounts using accounting software, you can add or edit parent and sub-accounts to the existing default chart of accounts. This will help you stay organized and understand the financial state of your business better.
