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Chart of Accounts: Understanding It

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There are a lot of business owners out there who do not view themselves as “detail oriented”. They minimize the details by calling themselves a big picture kind of person. When it comes to the accuracy of your accounting records, the more detail that exists, your ability to make better decisions about the big picture will be exponentially enhanced.

Your accounting system’s chart of accounts represents all of the possible categories that your business’s transactions could fall into. Most people are familiar with the terms “assets” or “liabilities” and “revenues” or “expenses”. You chart of accounts will break down each of those categories into much finer detail, enabling you as a business owner to know exactly where your money is coming from and exactly what it is being spent on.
Knowing the details by capturing transactions in the proper account will allow you to run ratios, cut expenses or focus on areas that are more profitable than others.

Assets need to be broken down by each bank account, not just “cash”. Your inventory needs to be broken out into each category if you have multiple types. For example, if you sell shoes, handbags and jewelry, you should have 3 categories at a minmum.
You may even choose to make it even more detailed if it makes sense. Your expenses should be detailed into multiple categories such as rent, office supplies, marketing, legal fees, etc.

Similarly, on the revenue side, your revenue streams need to be separately tracked. Using the same 3 categories, you should track revenue from shoes, handbags and jewelry separately. Let’s use a basic example as to why this is important:
Let’s assume you have total gross revenue of $1 million and total profit of $100,000. Well this seems great as you are profitable as a Company. If you tracked everything as one category, that is where the discussion ends. “Well I’m making money so I will continue in the same direction”. What if you tracked all 3 categories separately and found:

Gross revenue from shoes was $500,000 and profit was $200,000
Gross revenue from handbags was $300,000 and profit was 0.
Gross revenue from jewelry was $200,000 and you lost ($100,000)

That changes the decision making process doesn’t it? You still have $1 million in gross revenue and profit of $100,000, but only 1 of your 3 segments are actually profitable.

We have provided an interactive chart of accounts with some general categories. Remember, your account titles do not need to be set in stone. They should be titled in a way that allows you to best remember what they represent.

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